Don't put all your eggs in one basket.
And yes you guessed it, I am not referring to your easter basket 😉🐰💐
Dear Future Moneyqueen 👋
With Easter just around the corner I couldn’t help but come up with an analogy that suits both - Easter & the financial market. But of course, I’m not here to write about your easter basket.
What I want to write about today is the importance of diversification.
One belief I had for many years before getting started with investing, was that I have to pick the stocks I want to buy and hope I pick the right ones. Of course, if I pick the wrong ones, I end up losing my money.
In my mind, investing meant thoroughly analyzing companies, going through their financial reports, researching everything I can about the companies, and based on my research choosing the one I want to invest in. Already back then this seemed risky. How am I supposed to know if this one particular company will perform well in the future?
Don’t get me wrong - it’s still very important to do your research!
But turns out there is a much easier way to get started. One that allows me to invest in multiple companies at the same time. Rather than picking one company, I pick a pool of companies.
And what happens when you invest in multiple companies at the same time? Drum roll please… 🥁 You reduce your risk.
If one or even a few of these companies don’t perform well, you have a few more on the other side that can balance it out.
What I’m referring to are exchange-traded funds, in short ETFs. An investment option that has grown in popularity over the years, with more than 8,000 different ETFs to choose from. Usually, ETFs either track an index, for example, the S&P 500, FTSE, or MSCI, a sector, commodity, or other assets.
Now, you may ask yourself - How am I supposed to pick the right one out of the 8,000?
The short answer to this is: It depends on your risk profile and personal preference.
With any investment, it’s important to do your own research, but the metrics to look at when choosing an ETF are fewer than when trying to pick one single stock.
Things to consider should be:
What does this ETF replicate, ie. which companies and countries make up the most part of this ETF?
Inception date
Size of the fund
TER (Total expense ratio), which describes the total cost of managing the ETF
One other important thing to think about, and I already mentioned it above, is your risk profile.
While ETFs generally offer a lower risk due to their diversification, there are still differences between the choices of ETFs.
For example, do you pick an ETF that tracks an index which includes the biggest companies globally (lower risk) or do you believe that one industry will grow a lot in the future and pick a so-called thematic ETF? These will include only the biggest companies within a specific sector. Some options would be AI, health care, technology, biotech, and many more.
As you can imagine, these so-called thematic ETFs come with a higher risk, since you bet on one specific industry. In return, if you are right with your assumption and pick the correct industry, they also come with higher returns.
For example, if your portfolio included an ETF that tracks companies of the travel & leisure industry during COVID, it could have made a loss of 15% in 2020. On the other hand, your portfolio could have lost only 1% in 2020 and gained 25% the following year, if it included an ETF that tracks the health care industry. Have a look at the graphs below, for better visualization.
Yearly return iShares STOXX Europe 600 Travel & Leisure UCITS ETF
Yearly return Xtrackers MSCI Europe Health Care ESG Screened UCITS ETF
So, some good questions to ask yourself before you start are:
How risk-averse am I? A good exercise is to imagine opening your portfolio and seeing a big drop. How would this make you feel?
Am I willing to risk a bigger loss for the potential of a higher gain, or would I feel more confident with less movement and smaller gains?
🎁 As a little treat for easter, I have put together a questionnaire for you to assess your risk profile, which you can download here!🎁
But diversification is not just about investing in ETFs. There are many more ways to diversify. It’s always good to think about the asset classes you want in your portfolio. Apart from stocks you can invest in gold, bonds, crypto, real estate, or even collect watches, other luxury goods, cars & liquor to name just a few. At the end of the day, the choice is once again all about your preferences and risk profile.
And seeing the recent collapse of Silicon Valley Bank and Credit Suisse, I will also add - It’s good practice to spread your cash savings and not keep everything with one bank. While the money is usually insured up to a certain amount, I personally still feel more comfortable knowing that I spread my cash savings across different providers. Having multiple bank accounts is also great for budgeting, but that’s something for another day!
So, with this in mind - Don’t keep all your bags in one basket & enjoy your Easter break! 🐰🐇🐣💐