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The first step to protecting your wealth in volatile markets

Diversifying your wealth can help to manage the risk of losses when financial markets are more volatile.

Global investors had a nasty shock last summer, as fears of a sharp downturn in the Chinese economy rattled financial markets around the world.

Some European stock markets suffered falls of more than 5% in a single day, while a number of emerging market currencies hit new record lows against the US dollar. By the end of August, the Brazilian real had fallen by almost 40% against the dollar in a year.

After years of relative calm on financial markets, investors have been getting used to the return of volatility this year. But it doesn’t mean investors need to panic. There are steps you can take to manage your exposure to volatile currencies and investments and help reduce the risk of losses.

Performance of Brazilian Real vs. US Dollar

Performance of Brazilian Real vs. US Dollar

One of the most important is summed up by the basic principle of diversification, or spreading your wealth across currencies, regions and asset classes. It boils down to avoiding putting all your eggs in one basket. By diversifying your finances, you can reduce the chance of being hit by sudden changes in the value of one particular asset or currency.

Of course, it’s important to remember that diversification does not, in itself, guarantee that your wealth will grow or be preserved. All investments can fall in value as well as rise. But diversification can help smooth out the peaks and troughs of volatile markets, reducing the risk of heavy losses.

Diversifying your banking and savings accounts  

Storing some of your wealth in different currencies may help to limit your exposure to exchange rate fluctuations. These can be hard to predict and have a significant impact on the value of your deposits.

Keeping some savings in other currencies, perhaps because you have financial commitments abroad or plan to retire in a different country, helps to reduce the risk of losing out on exchange rate fluctuations later on.

Offshore banking and savings accounts can help, allowing you to save in different currencies, such as sterling, dollars or euros.

However, it’s important to remember that you might still lose money as a result of changes in exchange rates, even if you spread your wealth across a range of currencies. 

Diversifying your investment portfolio

Just as you should consider diversifying your savings, the same applies to investments.

Different asset classes, such as shares and government bonds, tend to react to the same market forces in different ways. By holding a broad range of assets in your portfolio, you’ll ensure that losses in one area can potentially be offset by gains in another.

You can spread risk by diversifying within asset categories too. A simple way to do this is through a fund, which is usually exposed to many different individual assets. A typical equity fund will contain more than 30 stocks, for instance.

Diversification also helps you manage the level of risk of losses you are taking with your investments.

Relatively risky investments, such as shares, have historically produced higher returns, but come with more risk of major losses. On the other hand, government bonds have generally been safer but have not produced gains on the same scale as equities. So it makes sense to have both shares and government bonds in a portfolio.

This said, it is important to appreciate that the past performance of investments is not a reliable indicator of their future performance. 

Investing around the world

You should also consider different segments or regions within asset classes. For instance, emerging market stocks have tended to be riskier than those in industrialised countries, but have sometimes produced strong gains.

Another important consideration is investing in a different currency, although you need to factor in its movement against your reference currency (the one in which you usually spend). If, for example, you gain 20% on UK stocks in a year, but the pound falls by the same amount against your reference currency, your net gain will be zero. 

Conclusion

Diversifying your wealth means spreading your risk and smoothing out returns. It won’t eliminate the risk of loss but may help to protect you from sharp declines in a particular market, by allowing you to profit from any upswings in others.

Investors have to always accept that they might end up with less than they originally invested. However, by applying these key principles, they might be able to face market volatility with composure and improve their wealth over the long-term. 

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