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When should I invest in broadly diversified investments and when should I invest in narrowly focused investments?

After you have made your decision on how much to invest in the three basic types of investments: cash, bonds and stocks (i.e. based on the amount of equity risk you are comfortable with), for most CPF members, investing in broadly diversified investments within that equity risk category should generally help minimise investment risk. In other words, investing in broadly diversified investments should help reduce risk compared with investing in narrowly focused investments in the same equity risk category.

However, there could also be reasons for investing in narrowly focused investments:

You enjoy riskier investments, even when the odds are not necessarily in your favour. You are happy to take on the extra downside risk of not diversifying because of the potential for higher returns, although you are aware that a positive result is not guaranteed.

 

For investments in the same equity risk category, it is reasonable to expect potential rewards over the long term to be very roughly the same for both a broadly diversified investment and a narrowly focused investment. However, you may want to accept the higher downside risk of a narrowly focused investment if you think that a narrowly focused investment may give better results in the short term.

 

For example, if you are confident about the recovery of the Japanese economy in the short term, you may wish to invest in a Japan focused unit trust even though this unit trust has higher risk than a better diversified global equity unit trust.