In the stock market, the paths of the main stock indexes diverged. Since mid-February, the Nasdaq Composite technology benchmark has fallen more than 10% from its local high, meaning it is widely believed to have gone through a full-fledged stock correction. At the same time, the S&P 500 and Dow Jones indices suffered much less, their fall from the last highs did not exceed 5%. Moreover, unlike the Nasdaq, which has so far managed to recoup only half of its decline, the S&P 500 and Dow Jones have already managed to update their historical records.
The Nasdaq correction is interesting to consider in the context of a strong rotation into the industrial sector. For the first time in five years, the Dow Jones dynamics outperformed the technology index for a month:
Since the beginning of the year, the Dow Jones (maroon) has outperformed both the Nasdaq (blue area) and the S&P 500 (yellow)
If the entire technology sector has entered a correction, then imagine what is happening now with the shares of individual companies that have recently become real magnets for the money of new investors. So, since the February highs, Tesla has lost almost 40% of its capitalization at the moment, and the value of the securities of Virgin Galactic, a super-popular aerospace company, has more than doubled. If the market is not going to go into a prolonged peak, then such a correction can become a cold shower for careless players. However, enlightened investors will immediately face questions: how can I learn from this whole situation and what can I change in my strategy?
First of all, you need to admit to yourself that no one in this world knows the future, not even analysts. Of course, in the investment environment, a real industry of forecasts has formed, which generates ideas for investments and sets target stock prices. If everyone around you suddenly starts talking about a stock that will soon earn hundreds of percent of the profit, please do not forget that even the most accurate forecasts remain only one of the probabilities with their chances of implementation. But what to do if you can not trust anyone, and you want to invest money? And so that not only to save them, but also to multiply them. The answer is simple — think for yourself and listen to the words of the Nobel laureate in economics Harry Markowitz, who said that the only free lunch in investment is diversification. Yes, it is diversification that will help to save capital from zeroing out and minimize the cost of a wrong decision. Let's figure out how it works. What is diversification?
Simply put, diversification is a way of not putting too much on one shoulder, or, if you like, putting all your eggs in one basket. Just as an experienced manager distributes the load evenly between subordinates, so a competent investor distributes the risk of his portfolio between different instruments. Of course, it sounds logical, because if all the money is invested in the shares of one company, then the entire portfolio will depend entirely on the fate of one business and the decisions of its management. It's a bad deal if you don't know the management personally.
As a rule, most tips on diversification come down to the fact that you should buy assets of different classes in the portfolio: stocks, bonds, and funds. This approach allows you to distribute risks and make profits in different phases of economic cycles. This is, of course, a simplification, but it illustrates the main point of the diversification process, which is to reduce the correlation between the instruments in the portfolio.If a risk is realized, it should not affect all of your capital, but only a part of it.
Different risks can be of different nature: sanctions, force majeure, currency fluctuations, recession in the economy, stock market panic, rising inflation, curtailing incentives, etc. Of course, the market will not be able to hide from all the threats at once, but a prudent investor with the help of diversification can build a real castle for their money, where each wall will protect against a specific risk.
So what?
Even if diversification seems like a stupid idea to you, do not dismiss it aside. A reduction in portfolio returns in the short term can keep your capital from being completely destroyed in the medium term. Use different types of diversification, and to make it easier for you to do this, we have compiled the following algorithm:
Carefully study all aspects of your investment ideas.
Determine the investment horizon and its goals.
Try to find as many risks as possible that can be realized.
Try to combine the types of investment diversification.
Pay more attention to those instruments that are weakly correlated with other assets in your portfolio.
Use exchange-traded funds, because they are by their nature ready-made diversified instruments.