What does diversifying investments mean?

Posted on July 22nd, 2019 | Categories - Investments, News

Investing is often filled with jargon and strategies that can make it seem complex. Diversifying may be one of those terms you’ve heard, but aren’t quite sure what it means for you and your investments. However, it’s an investment strategy that should be part of your decision-making process.

 What is diversifying?

To diversify your investments simply means to hold assets that differ. There are different options when creating diversity within your investment portfolio, it may mean different asset classes or could refer to the level of risk that’s involved.

The key reason for doing this is to limit the impact that investment volatility will have. Let’s say one industry suffers a dip, if all your money is invested in equities in this sector, you can see the value fall significantly. However, if you spread investments over several areas, gains in others can help offset the losses. Diversifying is investment jargon for not putting all your eggs in one basket.

This is why when you consider increasing the amount you invest, it’s important to look at the current assets you hold. It’s not a decision that should look at the pros and cons of one investment alone, you also need to explore how it will affect your investment portfolio. This should be done in conjunction with part of your wider financial plan, including what your goals are, too.

What are the different asset classes?

Holding your wealth in different asset classes is one of the ways that estates can be diversified, enabling them to better withstand potential shocks in one area. There are traditionally four asset classes.

  1. Cash: Whilst not investing, cash is an important asset class to consider when weighing up investment decisions. Having savings in cash gives you a secure safety net to fall back on should something happen. Under the Financial Services Compensation Scheme (FSCS), up to £85,000 is protected per person per authorised bank or building society. However, interest rates are unlikely to match inflation, meaning cash assets can fall in value in real terms.
  2. Stocks and shares: Stocks and shares, also known as equities, are what most people will think of first when they want to invest. Representing a share of ownership in a company, the value of equities can fluctuate. Ideally, equities will rise and value over the long term should deliver profits, but there is a chance that the initial investment is recouped. There are stocks and shares with varying levels of risk, which should also play a role in diversifying your portfolio.
  3. Property: Property is often viewed as an attractive investment opportunity for two key reasons. First, it’s a tangible asset. Second, over the last couple of decades, property prices have increased enormously in the UK. You also have the option to use property investment for capital growth and rental income. However, you also need to factor in maintenance costs and the fact that property is an illiquid asset that can be difficult to sell quickly if needed.
  4. Bonds: Bonds are used by governments and companies to raise capital. Here, your investment acts like a loan, with interest and payments being made over a defined period of time. Bonds can be purchased and sold through the secondary market, but it will depend on who has issued the bond. There is a chance that you will receive less back than the initial investment, however, they are usually lower risk than equities.

Spreading risk

As well as creating a diversified portfolio through using different asset classes, you should consider how risk is spread too. Your overall risk profile will be dictated by many things, but not every investment should be directly linked to this. Say you have an overall high-risk attitude and your financial situation means you’re in a position to invest in riskier assets. It’s still wise to hold some of your wealth in cash, bonds or lower risk equities. This can help protect the overall value and reduce the impact of volatility.

Creating a balanced portfolio

There’s no single investment portfolio that suits every investor. As with all financial decisions, it needs to take your personal situation and goals into consideration. Among the areas to consider when you’re building a well-balanced portfolio are:

  • What is your capacity for loss?
  • How do you view investment risk?
  • What are your goals when investing?
  • How long will you be invested for?
  • What other assets do you hold?

Working with a financial adviser can help you build a diverse portfolio with your aspirations in mind and enable you to continue reassessing it if life and goals change. If you’d like to discuss your investments, please get in touch.

Please note: The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.

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