Diversification – the investor’s tool we all need to talk about

Money's used as a means for getting us what we really want. Whether that’s for a house, for our children’s education or for when we retire. If you’re an investor, you’ve already taken the first step in making your money work that little bit harder for you – you’re on the path to securing your financial future.

Diversification is an essential tool we must use along the way.

There are different ways to diversify, but it doesn’t need to be complicated. To take it back to basics:

• Think globally
The best performing stock markets will usually change each year. We live in a world of unpredictability. If you can spread your investments around the world, you’ve got a better chance of making your investment journey a lot smoother.
• Think types
Different types of investments have different risks and rewards. Shares are generally more volatile than other investment types, so it’s important to think about holding other investments like bonds. Each should perform differently at different times, that’s why it’s usually best to have a mix.

This article gives you information to help you build a diversified portfolio, but it isn’t personal advice. If you’re not sure of the best course of action for your circumstances get advice. Our advisory service could help.

You can’t play investing

Investing isn’t a game – it’s impossible to make the right decisions all the time. Some investments won’t perform as you expect.

One of the most successful investors of all time, Warren Buffett, once said “I make plenty of mistakes and I’ll make plenty more mistakes too.”

Diversification example

Assume you’d narrowed down your investment choices to five investments. You don’t know how they’re going to perform.

If you’d fully invested into investments 1 or 2, you’d have either lost or made no money – can you really risk your future goal on one investment?

Instead, if you spread your money between the five investments in a diversified portfolio, stocks 3, 4 and 5 could smooth out the ups and downs. You never know, how they perform next year could tell a different story. You need to think long term when investing.

It’s exactly why diversification is so important. Instead of putting all your eggs in one basket, you should spread your money over lots of different investments. This means if one of your investments performs poorly, your other investments will hopefully pick up the slack to help you deliver the returns to help you reach your goals.

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So how do you start diversifying?

If you’re looking to take your first steps onto the path of diversification, funds are a good stepping stone.

A fund is a collection of investments chosen and run by a fund manager – by choosing some funds, you can let the professionals spread your money for you. Opt for instant diversification with a fund that includes different investment types across lots of geographies.

Mixed investment funds can be a good one-stop-shop. They usually blend shares and bonds in different proportions.

Overall, they use a range of strategies, so some are more cautious or adventurous than others. Choosing a more adventurous fund could give you more reward, or bigger losses – it can be a bumpy ride. Investors should look for funds that match their risk profile.

Investing in funds isn’t right for everyone. Remember, funds are investments that can go down as well as up in value, so you could still get less than you put in.

If you’re happy to build your own portfolio but just need some fund ideas, you could take a look at our Five funds to watch for 2021 or our Wealth Shortlist.

Use a core-satellite strategy

A diversified portfolio doesn’t just mean holding more individual companies. Unless you’re a full-time stock picker with decades of experience, you’re probably not going to reach a good level of diversification investing in your favourite stock picks.

Investing in companies you love and believe in can sometimes be a great idea. But it shouldn’t be your entire investment strategy. There’s more risk in investing in individual shares. Make sure you understand the companies you’re choosing. If the company fails, you risk losing your whole investment. Instead use them to put a personal spin on your wider portfolio.

While there’s no picture-perfect portfolio, we do think the core-satellite approach is a good one.

Think of owning a few shares like satellites. They’re the bits around the edges for that added pop of adventure and even more diversification.

Your core is your main group of investments – well-diversified and matching your risk profile. This should be the bulk of your portfolio. Usually a sensible mix of funds.

Key points for investing success

• Own investments from around the world
• Own a mixture of investment types
• Put a personal spin on your portfolio with a core-satellite approach

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