Diversification: Why & How To Do It

By January 13, 2020Investment Planning

This content is for information and inspiration purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice regarding your affairs please consult us here at WMM.

If you’ve ever watched Dragon’s Den, you’ll have noticed that Peter Jones, Touker Suleyman and the other investors look to invest in multiple companies. Each show might focus on a handful of investment opportunities, but looking at each of the Dragon’s investment portfolios as a whole, each one would feature multiple companies and asset types.

No experienced investor commits all of their capital to just one opportunity, no matter how promising it appears. This is true for Dragons and true for more “ordinary” investors who are looking to build their wealth throughout a career, securing a desired future retirement lifestyle.

Diversifying your investments across multiple funds, companies, asset types and markets isn’t simply about improving performance. Rather, it’s intended to help you achieve your investment goals over the long term, regardless of the level of risk you have chosen.

Diversification also helps to protect you against losses and unnecessary risk exposure. Consider the down market of January 2008 to February 2009. According to research by Strategic Advisers Inc., a portfolio comprising 100% stocks could have fallen by as much as 49.7% whilst a more “balanced” portfolio (e.g. including 25% bonds) would have fallen by 35%. In other words, diversification doesn’t guarantee you will not experience losses, but it can help you weather market storms and come out on top in the long term.

In this short guide, our financial planning team here at WMM will be sharing some ideas about how diversification can appear within a strong investment portfolio. Please note that this content is for information purposes only, and if you’d like specific financial advice regarding your own investment strategy then please arrange a free consultation with us.

Reach us via: 01869 331469


Diversify across asset classes

You might be forgiven for thinking you can only really invest in companies, but there are multiple asset types which are available to an investor. Cash is one example, although in today’s world of low interest rates it’s not a terribly good way to grow your wealth! However, it can be a useful component to an investment portfolio, providing some short-term protection against volatility.

Another common asset type includes fixed-term securities such as bonds. Here, you agree to “lend” some of your money to a company or government, on the basis that they promise to pay you back with interest. These investments can provide additional protection against stock market volatility, as they aren’t directly affected by down markets. However, they do tend to provide lower returns due to their lower-risk profile, and they can lose value if interest rates rise.


Diversify within asset classes

You might think that picking a few companies and bonds would, therefore, create a diversified portfolio. However, it’s important to take things further by picking a range of investment opportunities within each asset class. This helps to protect your portfolio if one of your companies or bonds underperform, or even fail.

Funds are a good case in point here. For instance, the Vanguard 500 Index tracks the S&P 500 index, which follows the performance of the 500 largest companies in the US. Rather than investing solely in Apple, Facebook or another large US company, you can pool your money with other investors via a fund such as this, minimising your risk exposure should one of them perform worse than hoped for.

However, most financial advisers would suggest you take diversification even further by investing in multiple funds, according to your investment goals and risk tolerance. For example, you could include 5, 10 or more additional funds, each of which tracks a different set of companies (perhaps in different sectors or industries).


Diversify across markets

One other important area of diversification to consider is geography. If you invest solely in UK stocks, cash, bonds and property, for instance, then your portfolio might have a high degree of diversification, but it will still be largely beholden to the UK economy and markets. A recession or other national disaster could still disproportionately damage your investments, even if they are spread across multiple asset types.

Considering global diversification is, therefore, a useful way to spread your risk and tap into different investment opportunities across a range of countries, regions and markets. You do need to be careful, however, as certain areas and jurisdictions involve different levels of risk. Developed countries such as Japan, the US, Canada and France are regarded as more “proven” markets compared to emerging and “frontier” markets, such as China and Vietnam. Make sure you speak to a financial adviser about how to incorporate global investments wisely within your portfolio, in line with your financial goals and personal risk tolerance.


Final thoughts

The above might make diversification sound easy to some people. However, achieving it takes considerable planning, knowledge and ongoing work to ensure everything is well-constructed at the outset, and to keep your portfolio on track over the long term. Plenty of investors fall foul of common pitfalls, such as “over-diversifying” their portfolio so that it has a high degree of protection, but also highly-inhibited growth potential due to investment dilution.

Getting the help of an experienced, independent financial adviser can be immensely helpful for clarifying your attitude to risk, the soundness of your investment goals and the appropriateness of different model portfolios for your particular situation.

If you are interested in starting a conversation about your financial plan or investment strategy, then we’d love to hear from you. Get in touch today to arrange a free, no-commitment consultation with a member of our friendly team here at WMM.

Reach us via: 01869 331469