How to Diversify Your Investments Properly
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Diversification – spreading your investments across different assets – is vital to help manage risk and potentially enhance your returns as an investor. Yet how can you diversify properly given the sheer range of investment options you can choose from? With 18% of people “scared” to make the wrong investment decisions and 15% saying they do not know about investing (or where to start), it is not uncommon for investors to lack knowledge in this important area. Below, we offer a short guide on how to diversify a portfolio effectively. If you want to discuss your investment strategy with us, please get in touch to arrange a no-obligation financial consultation:
01603 789966
Understand different asset classes
It helps to have a basic understanding of different asset types and how they compare. The two primary options for most individual investors are shares (equities) and bonds. The first refers to individual companies (stocks) or certain funds which trade on a recognised stock exchange, like the London Stock Exchange. The second refers to a type of “IOU” which can be issued by governments and companies to investors – promising to repay the principal over time, with interest. Cash is another, familiar asset class which provides interest to savers. Property is another asset class – providing capital gains upon sale and/or regular income payments (e.g. from tenant rent).
These different asset classes have unique features, benefits and drawbacks. Their performances also have a low correlation. For instance, when shares fall due to a market crash, investors often flee to bonds – driving up their prices. However, when interest rates fall, newly-issued bonds offer lower yields, leading investors to seek better returns elsewhere (e.g. the stock market). By including a mixture of the two in a portfolio, therefore, an investor can help to reduce volatility in the overall value of their investments.
Have a clear picture of your goals
Broadly speaking, are you looking to mainly grow the value of your portfolio or take an income from it? For instance, a 30-year-old in the midst of their career might wish to build their future retirement fund. If they are prepared to take on the higher risk, this person may, therefore, wish to focus their portfolio more towards “growth-oriented” shares (e.g. companies which plough their profits back into their business to increase value for shareholders). Conversely, someone nearing retirement may be more concerned with preserving the wealth they have already accumulated, starting to take an income from it. As such, they may be more attracted to dividend-paying shares and bonds. Another scenario might be a young person looking to build up a mortgage deposit for a house within the next 5 years. Here, the portfolio might include a higher percentage of cash to mitigate the impact of potential market crashes on savings.
Seize the global opportunity
Most investors are inclined to focus their portfolios on domestic assets (“home bias”). However, this can lead to missed opportunities for growth and/or income elsewhere. Other countries can offer distinct advantages that are lacking in UK markets. For instance, US stock markets offer more technology companies compared to the FTSE 100 and 250. Japan is a world leader in hardware such as cameras, medical equipment and scanners. Switzerland has a strong emphasis on commodity trading, engineering and pharmaceuticals. The UK market, by contrast, features more stocks in energy, financial and consumer goods. By diversifying globally, an investor can aid their efforts in spreading out their investments across multiple sectors.
Take a long-term perspective
With any investment, performance is not guaranteed and the value can regularly change over time. This can be disconcerting for some people, especially if they are accustomed to holding cash, which appears constant (although its value typically erodes due to the hidden effects of inflation). Taking a long-term perspective is crucial to help investors hold to their investment strategy during times of volatility. Yet diversification can make this easier on investors’ emotions. Different people have varying attitudes towards investment risk and volatility.
Some people are more comfortable with it compared to others. There is no right or wrong investor profile, in this respect. However, it is important to recognise your preferences and to diversify your portfolio in light of them. Failing to do this could lead to an investor making impulsive decisions later – e.g. “panic selling” during a period of market volatility, leading to crystallised losses which could have been avoided.
It is not uncommon for investors’ appetites for risk and volatility to change over time as their goals, values and circumstances evolve. Working with a financial adviser can help you keep track of your own investor profile as well as your asset allocation – helping to keep the two synchronised. Here, it is important not to tinker with your portfolio or to track its performance obsessively. Rather, periodic reviews with a professional (e.g. every 6-12 months) can help you address imbalances and maintain progression towards your goals.
Conclusion & invitation
If you are interested in discussing your own financial plan or investment strategy with us, please get in touch to arrange a no-commitment financial consultation at our expense:
01603 789966
