The importance of diversification
Putting all your money in one type of asset can be a risky strategy. You can help reduce that risk by ‘diversifying’ your assets, or in other words, spreading your money across a mix of investment types and countries.
As different assets and regions react differently to changes in political and economic conditions, this often improves the probability that poor returns from one or more investments are offset by the good performance of others. In turn, this helps improve the chances of more consistent returns over the longer term.
Diversification is an important fundamental principle to both those that are new to investing as well as the more experienced investor aiming to build a resilient investment portfolio.
The importance of diversification
Selecting the right mix
One of the major aims of diversification is to construct a portfolio of investments that don't all behave in exactly the same way. So while one part of your investment portfolio could be falling in value, the others may be flat or rising to balance it out. This difference in potential returns could offer some protection against all assets falling in value at the same time. Selecting the right mix can help to even out the damage inflicted by downturns, recessions or just routine fluctuations in specific markets. Different assets are affected by different factors: economics, interest rates, politics, conflicts even weather events.
Markets bumps are normal
Markets are unpredictable and it will always be difficult to foresee what will happen in the future. It may be wise not to take a short-term outlook, and avoid overreacting to immediate stock market moves. Taking a multi-asset approach could help to smooth out your returns. A well-constructed investment portfolio, designed around your time frame and keeping your portfolio diversified could be a prudent way to weather market uncertainty.
Asset allocation is king
Asset allocation refers to the decision of how much capital to invest and where, for example in stocks vs. bonds, in US vs. European stocks, how much to keep in cash and everything in between. Having the right balance - the optimal asset allocation - is what keeps you diversified in the market. Diversifying your investment portfolio across a range of asset classes, geographies and fund managers could help to reduce your overall risk.
Risky vs safe assets
If you need to protect yourself from the possibility of a short-term decline in the value of your portfolio, you are likely to follow the conventional wisdom of putting some of your capital into bonds rather than stocks. Whilst historically stocks have outperformed bonds over the long run, investing some of your money in bonds is likely to reduce the short-term ups and downs of your investment portfolio, which may allow you to sleep better at night.
Diversification is the only
free lunch in investing
The importance of diversification
Each colour represents a different asset class.
Source: Morningstar, data 1 January to 31 December. US dollars. Past performance is not a guide to future performance
The chart shows why it is so important to make sure your investments are diversified. As you can see, over time no single asset class or regions is a consistent top performer. Spreading your investments across a range of asset classes and regions could help smooth the impact of ups and downs in the market. One investment may perform badly in any particular year but this negative performance could be offset by the positive performance of another investment.
More articles from our New To Investing mini-series
Investment goals
Setting financial goals for investors lets them focus on decisions that will help their overall objectives, rather than monitoring the outcomes for a range of individual investments.
Understanding risk
For investors, risk is the chance that a particular outcome or financial gain differs from its expected outcome or return. It is important to realise that risk is an inherent part of investing and shares a fundamental relationship with returns: the more risk an investor is prepared to take, the greater the level of potential returns.
What is a fund
A fund is a type of investment that starts with a pool of investor capital, deployed by a fund manager according to a set of financial goals, providing access to a very wide range of investment opportunities, both broad and specialised.
Asset classes explained
Asset classes are groupings of investments that have similar financial characteristics. Each asset class carries its own set of risks and rewards.
Why invest globally?
Only investing locally means missing out on opportunities offered by global markets. Better diversification, more investment options and reduced volatility are among some of the reasons investors should consider investing globally.
Savings versus multi-asset
Both savings accounts and multi asset funds can offer benefits for investors. Over the long term, investing and saving can complement one another and potentially help towards achieving financial goals.
Why multi-manager investing?
Instead of focusing on just one type of investment, multi-manager funds invest in lots of other single-focus funds. This can allow investors to choose a single fund that diversifies investments and combines the talents of many fund managers are in one.