Blog

What is a diversified portfolio?

Let’s look at the different ways investors can diversify their investment portfolios to increase their chance of investment success.

portfolio_diversification

Investing in startups is easy, but tricky.

You don't have to be a financial genius to discover where to allocate your money, with more and more channels and resources becoming available. Online startup investing platforms such as SeedBlink are democratizing access to different investments in emerging companies to make it easy for beginners interested in becoming investors.

Diversifying the areas where you put your money, in contrast, is important because it allows you to keep an eye on other emerging markets and industries with bigger potential, and decrease the risks.

What is a diversified portfolio?

Diversification of the investment is a risk management technique by which investors allocate their capital across a number of different asset classes, geographies and industry sectors in order to spread their risk exposure.

Don't put all your eggs in one basket.

This is the main idea on each investor's mind to decrease the risks and loss of capital. If you are investing small amounts of money across diverse types of startups, it is more likely to increase the return on investment expected from them. Results of your investments can either fall or rise - you can only predict the trend up to a certain point. If you are only having a finite amount of money to invest, make sure you start with small amounts of money, while building a diversified portfolio when starting out.

"Investing in startups comes with a lot of unknowns and a lot of risks. Diversification reduces the risk but is also a way to get involved and support more projects"

says Marius Dondrici, Founder of Parenting Ads and tech startup investor.

Types of portfolio diversification

If you want to approach a portfolio diversification strategy, there are different asset classes that you can take into consideration before channelling your money in one direction.

So, where and how do we invest our savings?

To help us make more sense of this, Iancu Guda, Financial Analyst, will lead us through how an optimal portfolio and investment strategy looks like.

Even though the answer is not clear-cut as it depends on each individual and several factors such as yield objective and acceptable risk, constraints, time horizon, other sources of income, wealth size relative to expenses and needs, the risk of losing the current standard of living, investor profile, etc.

All of the above influence the investment allocation strategy, i.e., choosing the targets for different asset classes.

Additionally, he recommends following some of the diversification strategies listed below:

Vertical diversification

This is a concept that has the same original roots but is now applied differently in investing vs. business. Vertical diversification in the investment industry refers to the actual assets that the investor takes over, for example, stocks in different companies. Putting your money in different types of assets will decrease the risk without putting any limits on your potential returns.

Highly liquid assets (savings, cash reserves)

This is an “emergency fund” that must equate to the family expenses for about three months. A six-month family expenses reserve may be considered in exceptional situations with unforeseen liquidity needs.

In general, it is not recommended to have a higher proportion of highly liquid assets because money in this category is the "laziest": it produces the least amount of money.

Exposure to the real estate market

During life, exposure to the real estate market (own home included) should not exceed 30% of the average wealth. Of course, most people exceed this threshold when they purchase their first home. But, as you progress through life, saving, and investing in a diversified portfolio of assets, your financial capital grows, and you should limit your exposure to real estate to a maximum of 30%.

By the time we reach maturity, we should have a total wealth of at least three times the value of the house we own & live in. In Romania, the ratio between wealth and real estate exposure is 1.3, which is at least twice the optimal level.

Keep an eye on corporate stocks and bonds

Financial investments, i.e. government bonds and corporate stocks and bonds should represent 60% of your portfolio.

When we’re younger, our risk tolerance is higher, income is stable, and the investment horizon is longer, so the proportion of equities can be as high as 70%-80% from the financial investments; this should gradually fall to 30% after the retirement age.

So, we’re left with 5% - 10% (less the emergency/reserve fund) of the total wealth that can be allocated to alternative investments. These are generally high-risk asset classes with high return potentials (implied that losses can be significant too), such as minority stakes in private companies, art, precious metals, forex, or others (blockchain, ETFs, etc.).

The secret recipe of a healthy portfolio in private equity is a good mix of all these components, so make sure to go thoughtfully through them while doing your portfolio management.

Portfolio diversification and risk reduction

A diversified portfolio helps you and your startup funding process absorb the shocks of any financial disruption, providing the best balance for your saving plan.

Victor Bica, angel investor, confirms that a diversified investment strategy reduces risks.

“Whether we are considering startups, stocks, real estate, bonds, cryptocurrencies, or commodities, I believe that all of these need to be present in every investor's portfolio to a greater or lesser extent, depending on the individual's risk appetite and investment capacity.”

If you don't feel confident enough to invest alone, you can always join angel investment networks, crowd investing platforms, investment funds, or mutual funds.

Vlad Sarca, Partner at Sparking Capital, describes the ideal portfolio that needs to be aligned with the investor’s risk profile.

“An ideal portfolio should include fixed income instruments, shares in listed companies, and private companies – and tech startups are a good candidate. Depending on the individual risk appetite, one can also include other assets in the pot.

Regarding the “startups” part of the investment portfolio, I believe that one of the most important aspects is to invest in more than one company (around 10, ideally) and to put aside money for the following financing rounds launched by the same startups.”

5 tips and tricks for diversification

Perhaps the most important advice that each of us should always take to heart, is to permanently invest in our education. Human capital and intelligence solve problems and create wealth.

Reading and hands-on experience accumulated through diversified investing are two practices that should not be missing in our lives.

adds Iancu Guda, Financial Analyst.

1. Build your own investment thesis

Defining your terms for how much you want to invest, and who you are targeting are two essential steps in building a diversified portfolio. Some of the core elements that you should think about are:

  • What startup stages are you looking for?
  • What business models do you follow?
  • What type of industries and products would you like to invest in?
  • Your preference for the investment vehicle type.
  • The amount you are considering to invest.

Defining your investment thesis can be scary, but you can start now with SeedBlink! Sign up or log in and let us know your investment preferences by completing your Investment Thesis.

2. Have consistency

Once you start investing, one focus is to keep building your portfolio.

Add new deals to keep a diverse portfolio and decrease the level of potential risk associated with a single focused investment which might lead or not to a good performance.

3. Step out when it's needed

Analyze the past performance of your investments and don't force your luck into deals that are not deserving your attention. Keep an eye on your investment goals and on anything that's happening out there in the industry you are targeting. This way you can spot any market volatility that might affect your deals and bring certain portfolio risks!

4. Have a sector approach

We know investments are all about numbers, but diversification goes beyond it.

Through a multi-sector approach, you can mitigate potential risks associated with an industry or market over which you have invested, if there’s low traction in the market. Or maybe this industry is facing difficulties or different types of fluctuations.

5. Syndicate

If you are an angel investor, syndication makes the job easier for you. This investment strategy has gained more and more popularity and level of trust in the startup funding world as it can decrease the level of risk.

For example, syndication allows you to have a lower amount of money and brings the possibility to invest it in a wide range of companies. This way, you can keep diverse investment options, and keep the door open for any other upcoming rounds of funding!

What is your approach to portfolio diversification?

The list of advice can go on, and we are just touching the surface of the topic, but the real outcome comes from running your investment plan.

Use these pieces of recommendations as a starting point to learn how to master a diversified portfolio, and get started with your first investments to discover how they apply to real investment situations. You can start by exploring open opportunities on SeedBlink!

By Patricia Borlovan

PublishedFebruary 16, 2022


Share on

Be the first to know all about tech-trends, European growth, investments, and get exclusive access to all resources offered by our community!