A diversified portfolio is the investing equivalent of hedging your bets. Not putting all your eggs in one basket or not putting all your faith in one outcome. Diversifying your portfolio doesn’t make investing risk-free, but it certainly makes it less risky than it could be.
The way in which you might diversify your portfolio (the amount of money in each respective asset class, and the actual asset classes you use) will primarily be determined by the level of risk you intend to take. For example, a riskier portfolio might have more money in emerging market investments and less money in cash related ones.
By having money in a number of different areas, your portfolio’s overall performance won’t be dictated by a single asset class. This is a big plus because, well, we don’t know what a given asset class is going to do! If we did, investing would be much easier – we’d just put all our money in whatever’s going to rise the most.
Spreading your money across a number of different asset classes and sectors provides an element of balance to your portfolio. Because asset classes often move inversely i.e. rises and falls are correlated, your portfolio’s performance should benefit from a degree of smoothing. A reduced potential for volatility can be positive for both your portfolio and your own peace of mind.
The origins of diversification and modern portfolio theory stem from Harry Markowitz. He won a Nobel Prize for his approach to investing – showing how combining assets in different proportions can enable investors to manage their portfolio’s risk level while aiming to maximising returns.
This is the approach we take with all the portfolios we use. Combining different assets in such a way as to provide the best possible investment return for the level of risk an investor is willing and able to take. This is coupled with regular rebalancing to ensure the setup of the portfolio remains as it was intended.
A common pitfall
The concept of diversifying your portfolio is a relatively straight forward one, but actually putting it into action isn’t always so easy. You need to determine how much risk you wish to take, and then apportion your portfolio is such a way as to match that level. Once decided, you then need to choose the underlying investments that will make up each asset class.
This diversification process can often be overlooked by an investor. Putting your money into a fund that you’ve heard of, or choosing to invest in a fund that your investment platform is advertising, is a much easier way to begin. But it can be a dangerous way too. It’s all too easy to fall into the ‘all your eggs in one basket’ dilemma, and this can mean you’re potentially taking on a lot more risk than you actually realise or want to.
You don’t need to do it all
Bypassing the process of creating a diverse portfolio is not altogether that surprising because, as mentioned above, there’s a lot to think about. And on top of that, if you’re new to investing or don’t know too much about it, you might not even realise diversifying your portfolio is something you need to consider.
This is why investment advice can be so important. If you don’t have the time, inclination or know how needed to create a diverse and risk appropriate portfolio, it can be done for you. The emergence of online investment advice has made this process fully accessible and much more affordable than it once was for investors.
An investment proposal that has been fully checked for suitability – based on your own personal circumstances – can be produced and implemented in less time than you might think. An award winning investment team would then manage your portfolio for you. And at a cost not too dissimilar to doing it yourself, either.
Other content you might find interesting:
- Why rebalancing your portfolio shouldn’t be overlooked
- Online investing: turning complicated into simple
- Tax free savings: why investing in an ISA is a no-brainer
Any news and/or views expressed within this article are intended as general information only and should not be viewed as a form of personal recommendation. This article is not directed to, or intended for distribution or use in, any jurisdiction where such distribution would be prohibited. To the extent permitted by law, Wealth Horizon accepts no duty of care or liability for loss occasioned to any person acting or refraining from acting as a result of any material contained within this article. Where past performance is shown, this should not be taken as a guide to future returns. Investment in the stock market is not a suitable place for short term money. The value of investments and associated income may go down as well as up and you may not get back the full amount invested.
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