You don't have to be a finance expert to see the wisdom in the old proverb about not keeping all your eggs in one basket. It's why no sensible investor would ever go all-in on any asset class. That's the wisdom behind diversification: it's all about lowering risk and not losing money should one part of your portfolio go belly up.  

But does this advice apply to foreign exchange too? Yes – and here's how.

By expanding your view away from a single currency (say, the rand or the US dollar) and towards a diversified set of currency pairs, you'll see better returns and lower your risk. The more diversification you add to that portfolio, the truer that will be. If you have a highly concentrated position in just one currency, then you'll either win grandly or lose heavily, depending on how things turn out. That’s not the kind of bet that smart forex investors are into.

It’s about more than just holding lots of different currencies, though. Those currencies also have to behave differently, with one strengthening as another weakens so that gains in one will offset your losses in another.

Diversification and forex

Fact: currency is complicated. (Even though buying, spending and storing forex is easy with an app like Shyft, which also offers the cheapest forex rates on the market.) When you choose which currencies to diversify into, it's tempting to over-simplify matters.

Example time. The Australian dollar is generally regarded as very stable regarding risk factors like national debt and corruption (certainly when compared to a currency like the rand). However, is it really the best diversification against the South African currency?

Again, the rand is perceived as being quite volatile, with a daily range that's often several thousand pips high (a PIP, or point in percentage, measures the change in the exchange rate for a currency pair). But when you convert that into US dollar pips, is the rand really that much more volatile than, say, the British pound?

Neither of those questions has a simple answer. That's why, when it comes to currency, diversification means more than just a balance between two complementary pairs. Your portfolio could instead look something like 50% of one, 20% of another, 10% of two others and 5% each of another two. Precisely which currencies you allocate to those values will depend on a wide array of other factors, like which country you're living in, where you're moving to, and which country you intend to do business in.

The case for diversification

As we said, investing in currency can be complicated. So why, if it's already so complex, would you want to make it even more so by adding in all that extra diversification? That's a good question. And chances are high that at some point on your investment journey, someone will come at you with the hot take that diversification isn’t all that necessary. It’s also likely that they’ll trot out this quote from investment guru Warren Buffett: “Diversification is a protection against ignorance. It makes very little sense for those who know what they're doing.”

Ouch.

Of course, Buffett qualified that statement by saying: “Risk comes from not knowing what you are doing, so wide diversification is only required when investors are ignorant. You only have to do very few things in your life, as long as you don't do too many things wrong."

Nobody likes being accused of ignorance, but when it comes to the stock market, we can’t all be experts, either. You have a job, a family, a life, a Netflix habit. It’s unlikely you’ll be on top of the goings-on at all the companies you’ve invested in, or that you’re going to keep an eye on the forex market at all times so you can buy and sell at exactly the right moment.

Buffett would also be the first to admit that, when it comes to national currencies, plenty of things can go wrong – and most of them will be out of your control. We’re talking about things like Brexit, Covid-19, a Musk tweet, a war. All of those can – and have – sent currency markets into a spin.

In short

A well-diversified forex portfolio includes a variety of currencies that balance each other out, hedge against negative global sentiment, and play off commodities.

So go forth and diversify. It’ll lower your risk and increase your returns. And that's why you're in the forex market, right?

It’s never been easier – or cheaper – to invest in forex. Download Shyft to get started.