You have probably heard the statement: “Don’t put all your eggs in one basket.” When your eggs are scattered across multiple baskets, then the loss of one basket does not have to be fatal.
To follow this advice when investing, you must know where to invest your money in the UAE and how to allocate your money across investment opportunities.
This process, also known as diversification, is a powerful way to reduce risk. If basket A performs poorly and B and C perform well, for example, your portfolio can remain healthy. Imagine if you had put all you had in basket A.
In what follows, we will consider the UAE investment opportunities you should explore, the role they each play in your portfolio, and how combining them can help reduce your risk and even increase your risk-adjusted returns.
Stocks
Stocks remain one of the most popular investment assets. The main attraction of stocks is that they provide high returns, through both capital appreciation and dividend payments.
Bonds
While stocks thrive on high returns, bonds thrive on low risk. This is why investment portfolios have always tried to strike a balance between both.
Also, bonds and stocks have a negative long-term correlation. This means that when stocks are performing poorly, bonds usually step in with positive performance. Thus, adding bonds to a portfolio can reduce its long-term risk.
Mutual funds
Not many investors have the time or expertise to select individual stocks and bonds to buy. An alternative for this class of investors is to invest in mutual funds.
Mutual funds pool money from various individual investors and use them to purchase investments selected by expert fund managers. Every individual investor will have a stake/share in the mutual fund depending on the amount they invest.
Recent studies have however shown a fundamental weakness of mutual funds: they usually fail to achieve above-market returns despite the high fees paid by investors.
In essence, investors pay high fees to have these experts manage their funds, yet the experts fail to achieve a return that is better than just leaving their money in passive funds (which are usually cheaper).
ETFs
Given this fundamental failure of mutual funds, investors have gravitated towards passive funds like ETFs in recent times. These funds track the performance of a market index instead of trying to beat it. Since they are passively managed, they don’t charge high management fees (expense ratios).
One other advantage of ETFs is that they make diversification easy.
Though we have talked about asset class diversification so far (investing in multiple assets), there is another level of diversification within an asset class (asset-level diversification).
For example, purchasing an ETF that tracks the S&P 500 Index means you have a stake in 500 of the largest US companies, which operate in diverse industries. With just a $100 investment in such an ETF, you already have a significant amount of diversification.
REITs
Dubai remains one of the hottest property markets. Thus, it is natural for UAE investors to be interested in real estate.
However, achieving diversification in real estate is difficult. It requires a significant amount to purchase one property (even with a mortgage), talk less of diversifying across multiple properties.
Furthermore, real estate is illiquid, costly (closing costs and management fees), and has historically underperformed when compared to stocks.
A better solution to invest in real estate as an asset class is to buy Real Estate Investment Trusts (REITs). These are stocks of real estate companies (equity REITs) and mortgage providers (mortgage REITs).
REITs are liquid, as they can be bought and sold on the stock exchange market. It is also easy to diversify across multiple REITs by buying REITs ETFs. Finally, REITs have produced comparable returns to stocks across the years, making them a good way to diversify without losing returns.
Bitcoin
Bitcoin has established itself as a good way to achieve outsized returns (even better returns than stocks and REITs). Though many have complained about its volatility (which many use as a measure of risk), research has shown that even accounting for risk (what is called risk-adjusted returns), bitcoin still outperforms all other asset classes.
Gold
The main appeal of gold is that it has proven itself as a hedge in economic downturns and recessions. For example, gold outperformed the S&P 500 in six of the eight US recessions between 1973 and 2020.
Also, gold has proven that it can be a long-term hedge against inflation.
Therefore, by adding gold to your portfolio, you can further reduce its risk.
Like stocks, bonds, and REITs, investing in gold via ETFs is a good way to diversify your portfolio. By learning how to invest in gold ETFs in the UAE, you can achieve both asset-level and asset-class diversification.
If you are ready to reduce the risk of your portfolio and increase its risk-adjusted returns, diversifying across and within these asset classes is a smart investment strategy.
With Sarwa, you can build a diversified portfolio of stocks, stock ETFs, REITs ETFs, bond ETFs, gold ETFs, and bitcoin or subscribe to a personalized portfolio created for you based on your investment goals, time horizon, and risk tolerance.
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