Are Investment Diversifications Worth It?
What would you do if you had RM1,000 to grow? Where would you put the money? For the risk averse, most will turn to unit trust funds due to the relatively low risks and the higher return (relative to FDs).
With as little as RM1,000 (sometimes, even lower) you get an immediate investment exposure to a portfolio of stocks. Compare this to direct ownership of shares where RM1,000 would allow you to only buy a tiny bit of a particular company stocks.
Though investing in shares can potentially yield higher returns than unit trust funds, the transaction costs involved can be expensive when you start with a small capital. For example, investing in shares can incur high transaction cost due to the stamp duty and minimum commission charged by the securities firm. In the case of small investment capital, you would be better off buying unit trust funds.
However, is achieving investment diversification really the be all and end all method to successful investing?
A unit trust fund alone does not provide real diversification
There are many types of unit trust funds – equity, bond, balanced, fixed-income, commodity, specific theme and more. However, each type of fund only provides diversification in one asset class. If you want to achieve a wider diversification in different asset classes, investing in many different funds can do that.
Before you do that, consider the investment cost involved when diversifying into different asset classes.
You will need to pay upfront charges, fund management fees, trustee fees, and not forgetting the usual cost applicable to acquire certain assets by fund managers. All these costs added up over a long period of time will significantly affect your overall returns.
Financial planners always preach that you need to invest in different asset classes so that when one is not performing, the others hopefully will. Diversification is good to lower the risk of losing your money in investment, but more often than not, produces mediocre returns.
Should you diversify, or not?
The world’s richest investor, Warren Buffett once said “Diversification is protection against ignorance. It makes little sense if you know what you are doing.”
What Buffett means is, if you don’t know anything about shares or equity, diversification will protect you from losing a lot of money. Buying shares of eight companies is always going to be safer than buying from just one company.
Hence, unit trust is the perfect investment vehicle to help you achieve that diversification, no matter how much capital you have. But being “too diversified” may be a curse to you – because it affects your investment return. If you know how to do one type of investment well, it is fine to forego other investments out there.
Buffett preached that if you find a value buy, you can buy as much as you possibly can. Forget about diversification because it will just lower your overall return. However, take his advice with a pinch of salt, as it is only applicable for very experienced investors.
To diversify, or not to diversify
So what should you do? If you only have a small capital, should you break it into smaller amounts for different investments? Or should you take a leap of faith and put everything in a high return investment?
That is a question that you can answer once you know your risk appetite. For beginners who are averse to risk, unit trust funds provide a good start. But when you have substantial funds at hand, you can look into ways to invest directly in different assets on your own. Armed with sufficient knowledge and experience, you’ll most likely save more on costs and get higher return in the long run!
About the author:
KCLau is one of the top online financial educators in Malaysia. As a published bestselling author, he writes regularly on his popular personal finance blog. He also hosts regular and free financial training online featuring different experts. You can follow his latest updates by visiting www.KCLau.com.