Question

(1) Why does the average investor rely on financial advisors and brokers for advice? How can investors increase their financial literacy?

(2) What does it mean to have a diversified portfolio? What are the strengths and weaknesses behind such diversification strategies?

*As much detail as possible please*

Thanks in advance.

Answer 1

1.

Making financial decisions requires knowledge and research on all the aspects of financial planning – investments, insurance, retirement and tax. These 4 pillars should not be planned for separately.

Only a financial planner is well educated enough to connect these and fit it in a plan that suits a investor profile. The time required to manage your finances can be huge and take a toll on your personal and professional life if you begin to get deeper into it.

Some decisions can best be driven by planners, for example, the critical decision of borrowing from one investment class to fund another this cannot be done by you.

A financial planner :

• helps you set your financial goals in life (marriage of children, retirement among many others)
• allocates your asset across different asset classes keeping diversification in mind
• manages year on year cash flow till you are alive
• helps you insure everything dear to you
• selects the right products and executes the financial plan for you.

2.

Diversified Portfolio

Pros:

1. No single investment will wipe out your capital 100%. You can sleep better at night. That said, sometimes investments that are supposed to be unrelated may be related in some ways that reduces the diversification of your portfolio.
2. Suitable for unfamiliar investments. For example if you don’t know much about stocks, it is good to start investing in a diversified basket of 100 stocks to test out the water.
3. Lower volatility. Investment value fluctuate randomly and having only a few investments will cause the value of your portfolio to change more.
4. Will not miss out on any investments that suddenly outperforms unpredictably.

Cons:

1. Unable to diversify the risk that the whole market crashes. For example in 2008, practically all investments drop in value except currencies.
2. You may have too little of the investment that is doing well so your overall portfolio return is lower.
3. You may have to spend more time to manage your investments.