Diversification: that’s the challenge


Why should I diversify?

 

When people see success, they tend to join the success and often put all their eggs in the same basket. History is full of examples and maybe the most famous example is the tulip bubble in the Netherlands in 1637. At the height of the bubble exorbitant prices where paid for bulbs that didn’t even exist yet. People where buying on promises, hoping to sell it later at an even higher price. Prices would go higher and higher and many invested all their worth in bulbs. Until one day the bubble burst, supposedly because of the outbreak of an infectious plague. Prices dropped to a fraction of their inflated value, leaving many bankrupted. Would people have invested only a small amount of their wealth in tulips, and the remainder in other opportunities, they would just have had a small setback.

 

What is diversification?

 

Challenge of diversification

 

To safeguard against setbacks, you should diversify. Diversification is a term often used in finance, meaning not to invest all your wealth in one investment, but to spread it out over various unrelated investments. Like this, when one investment fails, it will be offset by the success of the other investments. Of course, the opposite is also true, if one of the investments performs really well, the benefit will be averaged out over all the investments.

To diversify, does not mean to have a lot of investments, but to have a lot of different types of investments, like stocks, loans (for example via crowdlending), real estate, and cash. Ideally, within the same category, you would also try to diversify, like investing in different loans.

 

How can crowdlending help to diversify?

 

Most people only know bonds to lend money, and more specifically government bonds. Through a government bond you lend money to a government, who has the obligation to pay it back at a certain date paying a pre-agreed interest rate. In general this is considered a safe investment, but by doing so you are not diversifying. Most people are already heavily invested with their government, think of your pension or your salary for public servants.

A better alternative would be to lend to companies. Before the existence of crowdlending this was difficult and costly, but crowdlending has made this option available to everybody: through an internet platform you can lend directly to various companies at once, at no or limited cost. And the low minimum investments make it very easy to diversify.

 

Example of such platforms in Spain are ECrowd for positive impact investments, and Arboribus or LoanBook for general small and medium company lending.

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