The old piece of folk wisdom, don’t put all your eggs in one basket, remains true for investors today.
Putting your eggs in one basket or all your cash in a single company stock can significantly increase your risk of loss. You need to spread the risk. This is why the number one rule of investing is diversification.
Diversification: Spreading your investments across different asset classes can help reduce risk. By diversifying, you can mitigate the impact of a potential downturn in any single investment.
How diverse do you need to be?
Obviously, you want stock in more than one company. We have all seen big name businesses, from Debenhams to Carillion, go to the wall.
Perhaps you want to invest in what you know. If you have an interest in technology, for example, you might want to have some holdings in a big name business, and some in a new challenger enterprise.
This is a first step to a diversified portfolio.
But what if the whole tech sector suddenly takes a hit? Something like a global semiconductor shortage could mean every technology business grinds to a halt. You need your portfolio to include several different sectors.
Look at the various sectors of the businesses that make up the FTSE100 for some examples.
But then what if the whole economy falters? The UK looks to be escaping the prospect of recessions, but it was a close-run thing. If the UK had gone into a prolonged downturn, many sectors that make up the economy would have suffered together.
The answer may be to be even more diverse, to look at several different types of asset, and to go global.
Reduce the potential for loss
Different assets and market sectors behave very differently in response to market conditions. When equities fall, for example, bonds tend to be on the up, and vice versa.
Shares are said to be negatively correlated compared with bonds, which means that both respond to the economy, but when one goes down, the other tends to go up. Having both might help protect you against the up and downs of the economic cycle.
The main classes of investment are shares, bonds, property and cash, and they perform differently. A diversified portfolio might be made up of holdings in them all. Spreading those holdings across several markets is also a sensible step.
So for example, Europe may emerge from the doldrums just as the US starts to look problematic.
A portfolio that’s properly diversified should reduce the chances of loss overall, because any holding that underperforms can be compensated for by those that are starting to deliver the results you want.
Increasing the potential for gain
But diversification may do more than simply reduce the risk of loss. It may actually help increase your returns.
If you trade regularly and don’t diversify, you are probably chasing performance and short term returns. When markets are unsettled, you might decide to move into lower risk investments and so a downturn in this situation may have potentially cost you the level of returns you wanted.
If you diversify, you can balance losses in one market with gains from another. Ride out short term extremes and you stand a better chance of enjoying underlying growth in all your sectors and markets in the medium to long term.
How to diversify
The first stage might be to spread your share investment across several businesses in a number of sectors. The second might be to balance those equities with bond assets.
Then you need to look at spreading your investments not just across sectors, but across entire global markets.
How can a small investor know which assets, from tens of thousands of companies, across dozens of sectors and global markets to invest in?
The answer is that they probably can’t – but the good news is that you don’t have to be an expert in global investment to get global resources working for you.
These are several investment funds managed with global diversity in mind. Managers know the markets, and the star performers within them, and invest accordingly.
Whether your objective is to maximise stability for your income, or the broadest base for your speculative investment the chances are that a fund exists to suit your purposes. At Continuum we can help you find it.
To get the diverse investment portfolio you need, call us today.
The information contained in this article is based on the opinion of Continuum and does not constitute financial advice or a recommendation to suitable investment strategy, you should seek independent financial advice before embarking on any course of action.
The value of investments can fall as well as rise and you may get back less than you invested. When investing, your capital is at risk.
Equity investments do not include the same security of capital which is afforded with deposit based investments.