Different Fintech companies point out that a possible solution to this problem is to invest a portion of the savings in various assets. By keeping the money in more investments, returns will even out, mitigating the issue.
In simple words, diversification is distributing money in various assets so that the exposure to only one investment is limited. And it can help build broad returns without forfeiting something in return, offering what financial experts call the only “free lunch.” on Wall Street. However, the picture is different for most retail investors, who may not be cautious. For example, for lack of diversification, in 1994, Robert Citron was Treasurer-Tax Collector for Orange County, California. Robert utilized a progression of profoundly used arrangements that included repurchase arrangements and drifting rate notes as the person in charge.
The finances he oversaw were worth around $8 billion, yet he depended on loan costs staying low, or, in all likelihood, he remained to lose for sure. However, loan fees rose, and thus, Orange County’s misfortunes added up to $1.7 billion and were constrained into Chapter 9 insolvency. Indicating that if the assets he invested were more diversified into different asset classes rather than only bonds, not all of the capital would be lost due to the bad trades. Diversification strives to smooth out unsystematic risk events in a portfolio, so the positive performance of some investments neutralizes the negative performance of others. However, the benefits of diversification hold only if the securities in the portfolio are not perfectly correlated—that is, they respond differently, often in opposing ways, to market influences.
According to “CNBC Make and Morning Consult,” One of every 4 Americans says they don’t have the idea or have no assessment on whether their assets are diversified. As per another study of 2,200 U.S. adults. 42% of respondents say they don’t effectively ensure their investments are diversified, and just around 34% of individuals say they do.
How to deal with it?
A Fintech that is already preparing for the lack of diversification in retail investors is U.S. Cherry, a firm based in Miami led by Colombians. The Fintech will offer specialized portfolios that will invest in the stock market in companies such as Apple, Amazon, real estate funds, emerging markets, ESG investments, or American treasury bonds for the most conservative.
The founders of the company focused on creating something disruptive, a simple solution, with low management fees, without the need for a large number of forms, offering a system where applications and signatures are completed directly on the phone, with more than 12 Investment strategies that are established on the risk profile of each client and based on the economic metrics of each company or funds in which it is going to invest and finally creating diversified portfolios of a global nature.
In previous years the founders wondered why people were so interested in buying only a few assets when there were so many profitable investment options in the markets. However, they found that the barrier to entry to such investments could be very high with “accredited investors only’ disclosures and excessive administrative fees. As a result, these strategies can only be reserved for significant capitals and sophisticated investors in many cases.
They concluded that the best way for retail investors to access diversified institutional-like investments was via a Fintech. Nicolás Reyes, the CEO of US Cherry, says that it would be very inefficient to offer the solution via a traditional “Hedge Fund” because it did not have the assurances for the investors of not being adequately regulated by the financial regulators that oversee U.S. Cherry. Furthermore, Hedge Funs usually retain the capital for a period via “lock-ups” where if money is to be withdrawn, high penalties are incurred, which will never happen at the firm.
Furthermore, Reyes, the CEO, explains that this was why they decided to regulate themselves in the United States, where the rules are stringent in terms of asset management, a more significant security measure, both for customers and the company. Stating, “We never pool the capital; we manage it. The account goes to each person’s name in a custodian firm in the United States, and this means that someone can withdraw the money at any time.
Studies and mathematical models have shown that maintaining a well-diversified portfolio of upwards of 30 companies is the most cost-effective level of risk reduction. For example, if you have only five individual companies on your portfolio, and one declines, this could cost you much money. However, let’s suppose you hold 30 different companies of different sectors on your portfolio. In that case, your results will depend on the overall investments. If some decline in value, others will go up, and on average, this effect is positive, thus creating an opportunity to gain the market’s full potential as a whole.
While diversifying won’t prevent losses, having a diversified portfolio makes a significant difference in the recovering period, as holding various assets can benefit the portfolio from the market upwards momentum.
To give an illustration if not diversified:
(Assuming everything is invested in only one stock)
- With a loss of 10%, one needs a gain of about 11% to recover. (A market correction)
- With a loss of 20%, one needs a gain of 25% to recover. (A bear market)
- With a loss of 30%, one needs a gain of about 43% to recover.
- With a loss of 30%, one needs a gain of about 43% to recover.
- With a loss of 50%, one needs a gain of 100% to recover. (That’s right, if you lose half your money, you need to double what you have left to get back to even.)
- With a loss of 100%, you are starting over from zero. And remember, anything multiplied by zero is still zero.
Nicolas, the CEO and Chief Investment Officer U.S. Cherry, finally states, “The importance of innovating in the sector and educating investors to make more educated decisions.”
U.S. Cherry will begin offering diversified investment portfolios from the first quarter of 2022. To learn more about its offer, visit uscherry.com.
(Beware that this is not financial advice and is only for educational purposes, market risk is always present please read all disclosures)
