Why a diversified investment strategy is important?
What does diversification mean?
Diversification means making sure you’re not relying on one type of investment too heavily. This helps to protect your investments and reduce the overall risk of losing money. There are three main asset classes – cash, bonds, and equities – and having exposure to them all will help reduce the overall level of risk of your investment portfolio. If one part of your portfolio isn’t doing well, the other investments you’ve made elsewhere should compensate for those losses.
It can work on so many levels
Investing in just one company is extremely risky, because if it doesn’t perform well, you’ll lose money. Investing in lots of companies means that even if one does badly, others may do well, which will limit your losses. You can further diversify your portfolio by spreading your investments over several geographical areas. If you invest in companies from different countries then even if, say, manufacturing is performing poorly in the UK, it might be flourishing in another region. You can take this up another level by investing in different sectors. Therefore, if manufacturing underperforms in several countries at once, other sectors you’re investing in could be outperforming their markets.
Thinking about risk and return
Diversification won’t stop you experiencing losses, but it can help you spread your overall risk. Do remember, though, that you can’t get rid of risk completely. Any investment can go up or down in value and you could make or lose money. You should find a spread of investments and a level of risk and return that you’re comfortable with.
Assets like bonds and gilts can help offset riskier investments like shares, but the downside is they don't offer the same potential for higher returns. Cash investments are also less risky than shares, but if the cost of living rises more than the rate of any interest you're getting, your money could fall in 'real' value over time.
The investments picked for your portfolio will depend on how long you plan to invest (which should be for at least a five-year term), how much risk you’re happy to take and your financial objectives.
