It might just sound like a bit of boring investing jargon, but 'diversification' is an essential ingredients that could help you grow the value of your investments over time. This is because it could help you to smooth out market bumps that is normal to experience when investing – such as dips in performance.
So, here are five things to know about diversifying your portfolio through diversification.
1. It means not putting your eggs in one basket
The simplest and neatest illustration for diversification is the old adage, ‘don’t put all of your eggs in one basket’. The meaning of this, of course, is that if something goes wrong, you lose all of your eggs.
To apply this to investing, think of your money as the eggs, and the basket as a company stock.
If that company runs into trouble, your shares could dive in value – leaving you with little more than scrambled eggs (aka, losses). However, by diversifying the companies, types of assets and regions you invest in, you're not relying on just one (or even a few) investments to perform well, which could help to minimise your overall losses.
2. It's about diversifying what you invest in
In essence, diversification means spreading your money out across as many different (hence, 'diverse') investments as possible. As we've already mentioned, this could be in terms of assets (like stocks and bonds), or even regions.
That could mean investing in 50, 500, or even 5,000 different assets. There’s no magic number as such, but many believe the more diversified your portfolio is, the better.
3. It could help you manage your risk
Just think of it this way. If you were to invest everything in shares in UK companies (for example) you would be exposing yourself to arguably more risk than if you were to buy shares in companies in lots of different countries and markets around the globe.
This is because, similarly to putting all your eggs in just one basket, if something happened in the UK to negatively affect share prices, it could impact all of your investments at once.
4. It could depend on your appetite for risk
A good diversification strategy might be to ensure you own a good range of investments like stocks, bonds, property, cash equivalents, and maybe some alternatives like commodities, if it suits your risk style.
How to choose the right mix of these for your style of risk is known as asset allocation, which can be a science and a full-time job in itself. But as we'll explain below, you don't have to do this yourself...
5. It doesn't have to be difficult to do
If diversifying sounds like a lot of work, there are shortcuts you can take, such as putting your money in investment funds.
Investment funds are like a multipack of investments, so they’re a cheap and convenient way to buy lots at once, rather than individually, which would generally cost more.
Funds can contain anything from dozens, to several thousand investments each, so they could be a great way to spread your money (and risk). However, you could argue that a fund is still a ‘basket’ of investments, and to ensure even more diversification, investors would need buy a number of them. However, the good news is there are thousands available, all containing a unique mix of investments from around the world.
Better still, if picking funds sounds like a chore, online investment services like Wealthify can choose them for you, building you an investment portfolio, based on how much you want to invest and your appetite for risk. Our investment experts will also manage your investments for you going forward for a small annual fee.
That way, you’ll have an expertly chosen diversified set of investments without having to do the work!
Investments can go down in value and you could receive back less than invested.
Wealthify does not provide financial advice. Seek financial advice if you are unsure about investing.
