Diversification: why it pays to be smartly spread
Important information: This article isn't personal advice. If you're not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.
You won't find many successful one-person businesses. Good businesses are made from teams – and the best teams are made from people with different skills, approaches and specialities.
In a sports team, you wouldn't pick players who are good at the same thing. It's great to have a team of fantastic goal-scorers, but if you forget to include a good goalkeeper or strong defenders your shooters' work might as well be forgotten.
No one player's more important than another. By everyone doing what they're best at, and working with others who do what they're best at, you have the best chance of winning the game.
Building a team of investments, which we call a diversified portfolio, is no different.
Investments can fall as well as rise, so you could get back less than you invest. This article isn't personal advice, so if you're not sure what to do, please seek advice.
What is diversification?
Diversification means spreading your money between different types of investment.
Whether it's types of companies, types of asset - like shares, bonds, funds and property - different parts of the world, or investment styles, there are lots of ways you can do it.
What good football teams teach us about investing
- The first thing you're taught when playing sport: don't chase the ball, stick to your position.
Go to any under 10s match and you'll see 22 players chasing the ball around the pitch. If your investments are all doing the same thing, you've probably left an open pitch behind you. That's where the danger is, so make sure you've got the whole pitch covered.
- The star player might be played every minute of every match. Will the team fall apart if they have an off day? Be careful of relying too heavily on one player. Nothing stays good forever.
- If multiple investors are chasing one particular investment, then they're probably buying it at a price higher than it's worth. Who's to say it's not just a short-term trend? And who's to say that buying it fits in with the rest of your overall plan?
Prepare when you can't predict
Investing isn't about picking winners. It's much less exciting than that.
Why guess the star players when you can buy the whole team?
If we could control how investments performed, the world would be a very different place. We can't – but we can spread our money, to be ready for their unpredictability.
The purpose of the margin of safety is to render the forecast unnecessary
And then when your investments do go up and down, provided you've spread them smartly, you won't have to play guessing games or make rash decisions when things happen.
How to diversify
- Types of investment, or asset classes – cash, bonds, funds, shares and property are the main ones, and they'll all have different risk levels. The idea is that they have different drivers of returns – each will perform differently at different times. As your age, goals and risk appetite change, then you'll probably want to change the amount you have in each asset class.
- Geography – why stick to one country, when you can have the world? Just like asset classes, different stock markets around the world are driven by different things. And often, the best performing stock market will change from year to year.
It might feel uncomfortable to put your money into areas which aren't doing well – but when the tide turns, and it usually does, you're more likely to be in the right place at the right time.