What exactly is diversification?
Diversifying your investment portfolio means having money invested across a range of different investments. That might mean diversifying across markets, countries, asset classes – from cash through to shares - products and even investment managers.
Investment markets don’t move in sync
There are good reasons to diversify your investments. All investment markets tend to move in cycles – moving towards a high point, then heading towards a low point, and returning once again to a high point.
No-one, not even the experts, can accurately predict when the high and low points will be. But if you’re invested across, say, a range of different assets classes – from cash through to shares - you may not need to, because those asset classes don’t always move in the same direction at the same time.
So when one asset is rising in value, another may be falling. Diversifying across different investments helps you to smooth out overall returns. You may miss out on some ‘upside’ if you’re not fully invested in the best performing asset class, but this can be compensated for by avoiding the potential impact of having all your funds in an asset experiencing a significant downturn.
Diversification can lower risk
Spreading your money across multiple investment types doesn’t just help to protect your portfolio from significant market movements. It can also help to smooth out your returns from one year to the next. And when used in conjunction with by using a longer term, regular funding strategy like ‘dollar cost averaging’, you may not have to focus as much on trying to pick when you believe is the ‘right’ time to buy into, or sell out of, an investment.
The bottom line is that no-one knows the future. You can help to protect yours by diversifying across a range of investments rather than relying on one type of asset only.
How you can diversify
The idea of diversifying your investments may sound challenging, especially if you have limited funds to invest.
One option that an investor may wish to consider is a managed investment. A managed investment can give investors access not just to a broader range of underlying assets (cash, fixed income, property and shares) but to a selection of investment managers.
What level of diversification suits you?
The blend of investments that is right for your needs will depend on your goals, your life stage and how you feel about risk.
You may, for example, be looking for investments that maximise income and preserve your capital. Alternately, regular income may be less important than capital growth.
The main point is the way there is no single ‘best’ way to diversify your investments – it all hinges on your personal goals and investment strategies.
Next: Managing risk
Managing risk
