A guide to diversifying your investment portfolio
This guide is designed to help you see that a balanced, well-diversified portfolio ought to be able to weather the short-term storms of market fluctuations. It should smooth out the various peaks and troughs and help you meet your financial objectives over the longer term.
It is the job of your financial adviser to help you diversify your portfolio by guiding you through the range of different assets, allocating your portfolio across the different options and, ultimately, helping you meet your objectives, while staying within a level of risk that is acceptable to you. It is important to acknowledge that, no matter what the type of asset, there will be risks involved. These risks are made up of two principle aspects:
- Market risk – the impact of economic factors, or government changes.
- Investment risk – the uncertainty and volatility of returns.
Diversification can help reduce both of these. Market risk cannot be eliminated but it can be reduced by spreading a portfolio over a range of different asset classes that should behave differently in different market environments.
The same holds true for investment risk. While shares are similarly exposed to investor sentiment towards the stock market on which they are listed, the investment specific risk will vary from company to company. Each share plots its own path, resulting in a smoothing of returns.
Diversifying across different asset classes will also lower the level of return, if you happened to have invested only in the best performing asset class.
The skill comes in balancing your asset allocation so the relative payoff matches your own attitude to risk and reward. The extent to which we need to diversify depends on how much volatility you feel able to deal with when your investments fall in value.
Diversify within asset classes – for example, within equities, the returns of some companies versus others (e.g. biotechnology v. utilities) are not related in any way. However they are exposed to factors that affect the overall equity market.
Diversify by geography – different markets are affected by different economic and financial factors. Being invested globally reduces the exposure your portfolio has to the economic and government conditions of one country. However global investor sentiment will continue to affect global markets.
Diversify within bonds and property – Government bonds do not behave in the same fashion as corporate bonds, or ‘sub-investment grade’ corporate bond. Also, commercial and residential property, are not always correlated in the returns they offer.
Next steps
In general it is best to start with a detailed assessment of your attitude to risk, and your tolerance to volatility. Depending on the time horizons for your individual goals, the level of risk you are prepared to take with different investments funds may be different. We have years of experience, helping clients plan and review their investments. For a review of your needs, contact us to arrange an appointment to discuss.
The value of investments and income from them may go down. You may not get back the original amount invested. Past performance is not a reliable indicator of future performance.