“Don’t put all your eggs in one basket.” This old adage sums up diversification, one of the most important principles of risk management in investing (and even in income streams). Diversification means spreading your investments (or sources of income) across different assets, sectors, or categories such that if one investment suffers or fails, others are there to cushion the blow.
Why Diversify? Because no investment is 100% safe or a sure bet, and different investments respond differently to economic conditions. By holding a mix, you reduce the chance that everything will go wrong at once. In technical terms, diversification can reduce the unsystematic risk (asset-specific risk) of a portfolio. The overall variability of your portfolio’s returns can be lower than the weighted average of the individual variabilities, because when one zigs, another zags.
Examples of diversification in practice:
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Across Asset Classes: Suppose you have KSh 500k to invest. Instead of putting all 500k in, say, shares of one company, you might allocate across stocks, bonds, real estate, and maybe a bit in a money market fund. If the stock market has a bad year, perhaps your bonds and real estate still hold value or even gain, balancing things out. In Kenya, a classic example was around 2011-2012: the stock market (NSE) had a slump while real estate was booming. Those with both assets were okay; those with only stocks saw losses. Conversely, in some periods stocks do great while property market stalls.
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Within a Class (Security Selection): Even if you focus on one asset type, diversify within it. For stocks – hold shares of multiple companies, preferably in different industries, not just one. For instance, have some bank stocks, some telecom (Safaricom), maybe some agriculture or manufacturing or utility. That way, company-specific issues (like a bad earnings year for one bank) or sector-specific issues (like a drought hurting agricultural firms) won’t torpedo your whole portfolio. If you had put everything in one company like, say, Mumias Sugar some years back thinking it looked good, you’d have lost almost all as the company collapsed. But if Mumias was say 5% of a diversified stock portfolio, that loss is contained.
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Geographic Diversification: Investing not only in Kenya but perhaps in regional or global funds can diversify against local economic downturns. If Kenya’s economy hits a rough patch, maybe global markets are doing fine, so any global investments would buffer. Today, via unit trusts or ETFs (exchange traded funds) on international markets (accessible through some local brokers or fintech apps), one can get exposure to global stocks or commodities. However, this is a more advanced step; at least diversify within the local context first.
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Income Diversification: Not exactly investing, but related to risk – having multiple streams of income can be seen as diversifying your “human capital/earnings.” For example, one might have a salaried job and a side business, or a farm producing on the side, or rental income. If one source falters (job loss, or business slows), the other source can help sustain you. Many Kenyans naturally do this (side hustles are common).
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Diversify in Savings Locations: Even spreading where you keep money can be a mini diversification – e.g., not all cash in one bank (just in case of an issue), or combining a Sacco and a bank and mobile money. However, note that too much fragmentation might be hard to manage; the main point is not to expose everything to one potential point of failure.
What Diversification is Not: It’s not a guarantee against loss. In a severe market crash (systematic risk), many assets could fall together (e.g., in a global financial crisis, most stocks fall, many businesses suffer). However, even then, diversification usually means some parts recover faster or still pay income. Also, if you diversify too thinly without knowledge, you might just mimic average market performance (which isn’t bad necessarily). Some say diversification is “the only free lunch in finance” – because you can reduce risk without necessarily reducing expected return, up to a point. But over-diversifying into too many similar assets can just be needless duplication.
A practical diversified plan for a modest investor in Kenya might look like:
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10% in cash/MMF for liquidity
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30% in government bonds or fixed income
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40% in stocks (spread across maybe 5-8 companies or a unit trust equity fund)
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20% in real estate (maybe plots or through a REIT if small scale)
This is just illustrative; actual percentages depend on individual situation. But such a mix means any given year, some part is likely doing okay. If stocks drop, maybe interest rates are up so bonds yield well. If both stocks and bonds suffer from, say, high inflation, perhaps real estate or commodity investments gain as people hedge inflation in property or gold, etc.
Another angle: diversifying over time, known as dollar-cost averaging which we discussed in Investing, also helps mitigate risk of bad timing. By investing a bit regularly, you diversify across time frames – you’re not betting all money at one price point.
The cost of not diversifying can be devastating: One story that often circulates is of individuals who invested all their pension in their employer’s stock – e.g., some employees of a large company X put their entire savings in company X shares. If company X then has a scandal or downturn, not only might they lose jobs, but their savings also plummet – a double whammy (this happened in the Enron scandal in the US). Translate here: if you work at, say, a bank, don’t keep all your money only in that bank’s shares or accounts; spread it out, just in case.
Diversification can also mean hedging one type of risk with another asset. For example, farmers in Kenya might diversify with weather-index insurance (so if drought hits, the insurance pays even though crops fail – that’s a different mechanism but conceptually spreading risk).
In summary, diversification is about resilience. It acknowledges that the future is uncertain – any investment could underperform or face challenges – but by having a portfolio that’s varied, you ensure that not everything will go wrong together. It’s a key part of managing investment risk: spread out your bets intelligently. This way, you aim to achieve smoother overall returns and protect your wealth from being too narrowly exposed.