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The importance of diversification in volatile markets

Investment Analyst Dominic Rowles looks at how the major sectors have performed over the last 10 years, and explains the different ways you could think about diversification within your own portfolio.

Important notes

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.

Coronavirus has disrupted global stock markets.

What started as an epidemic in China has now become a pandemic. At the time of writing, the virus has spread to more than 160 countries and sadly claimed more than 16,000 lives.

Most investors hate uncertainty. But the rapidly evolving coronavirus outbreak is causing one of the most uncertain situations we’ve faced in over a decade. As a result, the global stock markets have reacted negatively.

At times like this, we're reminded of the importance of diversification, and of investing for the long term.

This article isn’t personal advice. If you’re not sure if an investment is right for you please ask for advice.

2020 – a tough year so far

It sounds obvious, but if you only invest in one thing, you can only be right some of the time.

A portfolio fully invested in shares is likely to have done well over the last 10 years, but suffered this year. Bonds have sheltered investors better than shares this year, and some have risen in value, but they typically underperform shares over longer periods of time.

The chart below shows how funds in some of the main investment sectors have performed since the start of this year. Remember that past performance isn’t a guide to the future. Your investments will fall as well as rise in value so you could get back less than you invest.

Performance of the main IA sectors in the year to date

Scroll across to see the full chart.

Past performance is not a guide to the future. Source: Lipper IM to 23/03/2020.

Diversification makes sense in the long term too

The table below shows returns from the main investment areas over the last 10 years. You can see that past performance is definitely not a guide to future returns – the previous year’s top performers have frequently dropped towards the bottom of the table the next year.

Table showing comparative 10 year sector performance

Scroll across to see the full image.

Past performance is not a guide to the future. Source: Lipper IM to 31/12/2019.

Your financial goals, investment horizons, and risk tolerances are unique. There’s no one size fits all when it comes to diversification, but we think there are four types most investors should consider.

Asset class diversification

This means spreading your investments across assets like shares, bonds, cash and commodities. Shares have tended to deliver the best long-term returns but, they’re more susceptible to sharp short-term swings. Investments in bonds, for example, could help to dampen some of this volatility.

Geographical diversification

The returns of different stock markets can vary considerably. Working out which market will perform best in any given year is almost impossible. Having investments in most areas removes the need to predict – or guess – which area will outperform.

Sector diversification

Energy companies tend to do well when the economy is thriving. While companies selling consumer essentials tend to generate more consistent profits, as people buy products such as toothpaste and shampoo regardless. Diversifying across different sectors should increase the chance of some of your investments performing well wherever we are in the economic cycle.

Investment style diversification

There are many different approaches to fund management. Some managers seek undervalued companies that have been overlooked by others, while some look for established companies with strong cash flows. Some managers prefer larger companies and some prefer smaller. As different areas perform well at different times, we suggest a mixture of investment styles to help achieve more consistent returns.

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    Important notes

    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.

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