Investing in any capacity can often be a daunting task, largely because there are so many options to choose from, and each bear inherent uncertainty. As such, it is imperative that new investors understand the importance of minimizing their risk to a single or sole few asset classes. Recent events in Canada, such as the country’s worst mutual fund month in history, exposes a key takeaway that any trader, new or seasoned, should follow. That is, never limit yourself to just one financial instrument.
Diversifying your portfolio
It is crucial you understand the risks of investing and how to mitigate financial damage before undertaking any investment endeavour. An example of this can be found in cryptocurrency, which is notoriously volatile. It is underpinned by blockchain technology that offers inherent security and is difficult to compromise. A blockchain is, fundamentally, a series of time-stamped digital blocks that contain transaction data and are stored in sequential order.
During 2017, the world’s first cryptocurrency Bitcoin entered an unprecedented bull run and surged to an all-time high of approximately $20,000. Yet mere months later, a bear market plagued the asset class and its value dwindled significantly. Had you purchased Bitcoin at its highest point and held on through the bear market, your losses would have been significant. However, capitalizing on Bitcoin prior to its bull run and selling at the currency’s peak would have produced significant profits also.
The stock markets are somewhat more stable, though still volatile. A stock is a financial instrument that equates to ownership over the company or corporation that has issued it. They are also referred to as a share; however, you would need to own a large majority of them to have any real influence over the company. Stock prices are, ostensibly, tied to how that particular company is performing in a number of ways.
For example, the value of Netflix stocks would have been far lower when the service first launched, compared to when it had risen to prominence. As you can see, if you were to have placed all of your investment capital into a single company and it suddenly plummeted for whatever reason, you are at risk of losing it all, while adversely, the positive performance of such a company would represent increased profit yields instead.
Traditional forex markets are notably different, as users focus on trading currency pairs as a means for investment. Some brokers even provide Call and Put options on FX pairs, but for this you’ll need access to an options trading platform which are rare to come by. They, typically, select a base currency alongside another to make profits in periods where a currency’s value increases or decreases. There are many platforms to choose from, with resources such as Top Rated Forex Brokers’ comparison list being available to help find suitable brokers offering the most competitive prices.
Each investment opportunity, such as traditional stocks, commodities, bonds through to trading in the foreign exchange (forex), and cryptocurrency markets, has its own intrinsic benefits and limitations. Cryptocurrency opportunities are by far and large the most volatile, yet the potential profits far exceed those in traditional stock markets.
On the flip side, bonds are not subject to the same rules as cryptocurrency or stocks, and while they can be volatile, they generate passive income. The Canadian government discussed investments and defined a bond as a “certificate you receive for a loan you make to a company or government (an issuer) – in return, the issuer of the bond promises to pay you interest at a set rate and to repay the loan on a set date”.
Investing into bonds may not yield large and instant profits but they can be used to broaden your investments and thus, leave you less susceptible in times where your other investments have taken a turn the worse.
Volatility also represents opportunity
All the above should be enough to say, volatility will always come in tandem with investing. If there is no risk, there is no reward. Diversifying your portfolio does not guarantee you will be risk-free, but it does limit how much damage a single asset class could cause financially. It is also always recommended that before you make any decision relating to money, investments or otherwise, you first conduct thorough research to understand what you are about to commit to.