What is Diversification?
We believe a diversified portfolio is a key to successful investing, helping to mitigate risk and provide the potential for more even returns over time.
Understanding Risk
Halal Investing is an Islamic approach to investment decision making. Financial products are determined as permissible only after a detailed shari’ah-based review and approval.
Because Islamic financial law is centered on the concepts of social justice, ethics, and finance as a means to help build sustainable communities, in its essence, halal investing holds within itself the western concept of ethical and socially responsible investing, too. As a result, halal investing may be a preferred choice among Muslims and non-Muslims alike.
Systematic or Market Risk
- Not specific to one company, industry or investment vehicle but impacts the entire market.
- Unavoidable and undiversifiable.
- Can be caused by inflation rates, exchange rates, political instability, war, or interest rates.
Unsystematic or Diversifiable Risk
- Specific to a company, industry, economy, market or a country.
- Avoidable and diversifiable.
- Can be caused by business or financial risk.
How Does Diversification Help Temper Market Volatility?
At its root, diversification primarily aims to limit the impact of volatility on your portfolio, which in turn may help maximize returns. When your portfolio is diversified, it holds securities across industries, sectors, and sizes.
Let's Look at an Example
Assume your portfolio only has travel industry stocks, as an example, including airlines, railways, tourism companies, travel agencies, etc. Due to an unexpected pandemic, vacationing and tourism is greatly impacted. In fact, even essential travel is reduced significantly. As a result, it is likely that all these stocks in the travel industry take a deep dive and experience losses. Although you had multiple companies in your portfolio, since they all belonged to the same/similar industry, they were similarly impacted by the same adverse events.
On the other hand, let’s say you had spread your investments across the travel, healthcare, and IT industries, with some domestic and some international stocks. In the event of the pandemic, although the travel industry stocks dropped, the healthcare and IT industry stocks rose during the pandemic due to the need for the products and services they provided. The impact of the dip in travel stocks was thus balanced out with the rise in the other types of stocks.
