Note: This article discusses Indonesian financial products and markets. The principles apply globally, though specific products, regulations, and tax treatments vary by country.

Reducing Risk: Diversification in Indonesia

Diversification is the most important concept in investment risk management. The principle is simple: don’t put all your eggs in one basket.

But diversification isn’t just about owning many stocks. There are several layers of diversification you need to understand. This is an important part of asset allocation and the risk-return spectrum.

Why Diversification Matters

Imagine putting all your investment money into one stock — say, a coal company stock. If coal prices drop, energy transition accelerates, or the company runs into trouble, your portfolio could fall 50-90%.

Conversely, if you own 30 stocks from various sectors, a problem at one company only has a small impact on your overall portfolio.

Diversification doesn’t eliminate risk, but it reduces unnecessary risk.

Systematic vs Unsystematic Risk

Understanding the difference between these two types of risk helps explain why diversification works:

Unsystematic risk (specific risk):

• Risk specific to one company or sector
• Examples: management fraud, factory fire, product failure, regulatory sanctions
• Can be eliminated through diversification
• This is the risk you eliminate by owning many stocks instead of one

Systematic risk (market risk):

• Risk affecting the entire market
• Examples: recession, interest rate changes, inflation, political crisis
• Cannot be eliminated through diversification
• This is why even diversified portfolios still go up and down

When you own 30 stocks, company-specific problems average out. But when the entire market falls, all stocks tend to fall together (though some more than others).

This is why diversification across asset classes matters more than diversification within stocks.

Understanding Correlation

Correlation measures how two assets move relative to each other. The correlation coefficient ranges from -1 to +1:

Coefficient	Meaning	Diversification Benefit
+1.0	Move perfectly together	None
+0.5 to +0.8	Tend to move together	Limited
0	No relationship	Moderate
-0.5 to -0.8	Tend to move opposite	Good
-1.0	Move perfectly opposite	Maximum

Examples of typical correlations in Indonesian portfolios:

Asset Pair	Typical Correlation	Note
Indonesian stocks - Indonesian bonds	+0.2 to +0.4	Moderate diversification benefit
Indonesian stocks - Gold	0 to +0.3	Gold often acts as safe haven
Indonesian stocks - USD deposits	-0.1 to +0.2	Rupiah weakness often coincides with stock market stress
Bank stocks - Non-bank stocks	+0.7 to +0.9	High correlation within equity market

Important: Correlations are not stable. During severe crises, many asset correlations tend toward +1 (everything falls together except the safest assets).

Real-World Portfolio Performance: A Comparison

Let’s look at how different portfolio compositions might perform across various market conditions (illustrative ranges based on typical asset behavior):

During Strong Bull Market (2017-2018):

Portfolio	Approximate Return
100% Indonesian stocks	+15% to +25%
70% stocks + 30% bonds	+10% to +18%
50% stocks + 50% bonds	+7% to +13%
100% bonds	+5% to +8%

During Market Crisis (2020 COVID crash):

Portfolio	Approximate Decline
100% Indonesian stocks	-30% to -40%
70% stocks + 30% bonds	-20% to -28%
50% stocks + 50% bonds	-12% to -18%
100% bonds	+2% to +5% (bonds rallied)

The diversified portfolios lost less during the crash but gained less during the bull market. That’s the trade-off.

Layers of Diversification

1. Diversification Across Asset Classes

This is the most important layer of diversification — dividing your portfolio between stocks, bonds, and money market instruments.

Asset Class	Good Conditions	Bad Conditions
Stocks	Growing economy, market optimism	Recession, financial crisis
Bonds	Falling interest rates, uncertainty	Rising interest rates, high inflation
Money market	Anytime (stable)	Negative real returns during high inflation

Note: Historical correlations between asset classes can change, especially during systemic crises.

When stocks fall, bonds often rise or stay stable. The combination produces a smoother journey.

Simple example:

• 100% stocks portfolio: 12% average return, but could be -30% in a bad year
• 70% stocks + 30% bonds portfolio: 9-10% average return, worst decline maybe -15% to -20%

2. Diversification Across Sectors

Indonesia’s economy depends on several major sectors. If your portfolio is too concentrated in one sector, you’re taking unnecessary risk.

Sector	Weight in IHSG (Jakarta Composite Index, estimate)1	Specific Risk
Financials (banks)	~35-40%	Credit crisis, rising NPL (Non-Performing Loans)
Consumer	~15%	Declining purchasing power
Energy & mining	~10-15%	Falling commodity prices
Telecommunications	~8-10%	Regulation, price competition
Infrastructure	~5-8%	Government policy

Note: IHSG is heavily concentrated in the financial sector. The four big banks (BCA, BRI, Mandiri, BNI) alone can represent 25-30% of IHSG.

Index funds tracking IDX30 or LQ45 automatically provide sector diversification, although still limited to the largest stocks.

3. Diversification Across Companies

It’s better to own 30 stocks than 5 stocks. This is what you automatically get from index funds:

Product	Number of Stocks
Single individual stock	1
IDX30 index fund	30
LQ45 index fund	45
SRI-KEHATI index fund	25

By buying one index fund, you’re instantly diversified across dozens of companies.

4. Geographic Diversification

This is often overlooked by Indonesian investors: your entire portfolio is in one country.

Risks of being concentrated in Indonesia include:

• Dependence on commodities (coal, CPO, nickel)
• Political and regulatory risk
• Currency risk (Rupiah tends to weaken vs USD)
• Indonesia’s economy is “only” ~2% of global GDP

Ways to add geographic diversification:

• Mutual funds that invest in global stocks (limited in Indonesia)
• US stock investing via platforms like Gotrade or Pluang
• USD mutual funds available from some investment managers

For beginner investors, domestic diversification (IDX30 + bonds) is already quite good. Global diversification can be added as your portfolio grows.

5. Time Diversification (Dollar-Cost Averaging)

Regular monthly investing is also a form of diversification — you buy at different prices each month, reducing the risk of entering at “peak prices.”

Month	Price per Unit	Investment	Units Received
January	Rp 2,000	Rp 500,000	250
February	Rp 1,800	Rp 500,000	278
March	Rp 2,200	Rp 500,000	227
April	Rp 1,900	Rp 500,000	263
Total	Average Rp 1,968	Rp 2,000,000	1,018

With regular investing, your average purchase price (Rp 1,968) is lower than the average market price (Rp 1,975) because you buy more units when prices are cheap.

How Much Diversification Is Enough?

Diversification has diminishing returns — after a certain point, adding more assets doesn’t significantly reduce risk.

Practical guidelines for Indonesian investors:

Level	What’s Needed	Sufficient?
Basic	1 index fund + 1 money market fund	✅ For beginners
Good	+ fixed income fund or SBN	✅ For most people
Complete	+ exposure to global stocks	✅ Ideal portfolio
Excessive	10+ different products	❌ Too complicated, marginal benefit

Don’t get trapped in over-diversification. Having 3-4 right products is better than 15 overlapping products.

Wrong Diversification

Some common mistakes:

1. Buying 5 different IDX30 index funds — This isn’t diversification. They all contain the same thing (the same 30 stocks). Just buy one.

2. Buying individual stocks “for diversification” — If you already own an IDX30 index fund, buying BCA stock separately actually increases concentration, not reduces it.

3. Considering property in one city as diversification — Owning 3 apartments in Jakarta isn’t diversification. They’re all exposed to the same Jakarta property market risk.

Conclusion

• Diversification is the most effective way to reduce risk without reducing expected return
• The most important layer: across asset classes (stocks + bonds + money market)
• Index funds automatically provide diversification across companies and sectors
• Regular investing (DCA) provides time diversification
• No need to overdo it — 3-4 right products are enough
• Diversification protects you from what you don’t know

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Disclaimer: This article is for educational purposes only, not investment advice.

Related Articles

• Asset Allocation
• Risk-Return Spectrum
• Portfolio Rebalancing: Complete Guide
• Stock Market Risk
• Risk Premium: Why Stocks Are Riskier Than Bonds

Footnotes

1. IHSG sector composition changes over time. Current data can be viewed at IDX - Market Statistics ↩