With stock markets fluctuating every week, individual investors clearly need a safety net. Through diversification, they can manage their exposure to risk and help prevent their entire portfolio from losing value.
Portfolio diversification is a technique that reduces risk by allocating investments across various financial instruments, industries and other categories. It aims to maximise returns by investing in different areas that would each react differently to the same event.
Diversification may not be the sexiest of investment topics. However, most investment professionals agree that, while it does not guarantee against a loss, diversification is the most important component to helping you reach your long-range financial goals while minimising your risk. Keep in mind, however, that no matter how much you diversify your portfolio, you can never reduce risk down to zero.
Diversification gives you greater potential for growth because your portfolio is not dependant on any one company, fund or sector doing well. So if one of your investments is performing less well, others should be performing better to compensate. This helps reduce your potential risk.
Different markets perform differently at different times, so one of the most effective ways to achieve consistent returns is to spread your money between several different types of assets or markets. In this way, portfolio diversification can be achieved by:
- Asset class - the simplest form of diversification is spreading your money across equities, bonds, cash and property
- Country - investing in the UK and internationally means you are not limiting your investment to the fortunes of only one market
- Industry sectors - consider investing across a variety of sectors such as energy, financial services, industrial and health care for example
- Investment style - creating a balance between funds that concentrate on growth opportunities and others that focus on value stocks - those whose potential has not yet been recognised by the market.
Please remember, when investing internationally, changes in currency exchange rates may affect the value of an investment.
Genuine portfolio diversification
Genuine portfolio diversification should mean that you invest in different asset classes that are not so tightly correlated with each other, and won’t rise or fall at the same time. You should also aim for a spread of risk that reflects your priorities in life; less risk if you’re not far away from the time you'll need access to your invested capital; more risk if that time is long in the future.
For many investors, this will mean cash, bonds and shares (or funds that hold them) in varying proportions, with maybe property or gold as well. If you start investing relatively early in your life, you have another way of spreading risk: time.
Investing in funds provides a simple and effective method of portfolio diversification. Because your money is pooled together with other investors, each fund is large enough to diversify across hundreds and even thousands of individual companies and assets. What's more, all the investment decisions are managed by leading investment experts.
Please note past performance should not be used as a guide to future performance, which is not guaranteed. Investing in Funds should be considered a long-term investment. The value of the investment can go down as well as up and there is no guarantee that you will get back the amount you originally invested.
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