Apparently it is British Pie Week so it seems like a great excuse to discuss diversification. With the stock markets constantly moving up and down, investors need some sort of safety net. Diversification can work this way and can prevent your entire portfolio from losing value.
Diversification of your investment portfolio isn’t the most interesting of topics. However whilst investment professionals agree that diversification does not guarantee against a loss, it is the most important component to helping you reach your long-term financial goals while minimising your risk.
There are, of course, no guarantees with investments and no matter how much diversification you have, it can never reduce risk down to zero.
There are three main things that a diversified portfolio should have:
- The portfolio should be spread across many different investment sectors such as cash, bonds, property and equities.
- The funds should vary in risk. You don’t want a portfolio with all high risk funds even if you have a high attitude to risk. Picking investments with different rates of return will ensure that large gains offset losses in other areas.
- The portfolio should have a variety of underlying investments, different industries, size of companies etc this will minimise unsystematic risk.
Benefits of Different Sectors
Cash investments generally offer a low return compared to other investments. They are also associated with very low levels of risk. Cash offers a safe haven for part of the portfolio and can be used to retain earned dividends for payment at a later date.
Property can be split into two areas: real estate property that has been purchased with the intention of earning a return on the investment, either through rental income, the future resale of the property or both. An investment property can be a long-term endeavour or an intended short-term investment as in refurbishment, property is bought, renovated, and sold at a profit. Or you can invest in companies that build new properties for sale, these are generally residential houses but not always.
This uses a debt instrument such as a Corporate Bond or Debenture, which allows companies to raise finance for a variety of projects and activities. An investor loans money to a company in exchange for interest payments. A fixed-interest security pays a specified rate of interest that does not change over the life of the instrument. The face value is returned when the debt matures.
Most people know these as GILTs when the government want to raise money they will sell a new tranche of Government Stock. As with the Fixed Interest sector the money is borrowed for a defined period of time at a variable or fixed interest rate.
UK Equities are funds invested in companies listed in the UK. Some invest for growth, while others will look to produce some growth and income (usually by investing in companies that pay high dividends). These companies can be of varying sizes and a spread of different ones can provide growth opportunities regardless of what the economy is actually doing.
International equities are considered shares of companies, which are headquartered outside the UK. The economies of the world are often at different stages in their economic and investment cycles. Therefore by investing in different markets you can reduce the risk of the overall volatility of your investment portfolio.
A Multi-Asset fund is a combination of asset classes (such as cash, equity or bonds) used as an investment. A multi-asset class investment contains more than one asset class, thus creating a group or portfolio of assets. The weights and types of classes vary according to the individual investor. This can be an excellent way for a new investor to dip there toe in or can be used to reduce the risk of a more concentrated portfolio.
How many is enough?
Another question people often ask is how many stocks should they hold to reduce the risk of their portfolio. To hold individual shares you need to have at least £250,000 in order to get a broad enough spread. A better way to invest is through investment funds which is more appropriate for those with as little as £1,000. The managers of these funds invest in individual companies and could hold between 20 to 60 different companies, depending on the type of fund. This is again an excellent way to get a good spread of types of companies which further reduces the risk and gives you better growth potential.
Finally a diversified portfolio is only as good as the research carried out when investing. It is important that your portfolio is regularly reviewed because today’s top investments may not be so in a few years time. By regularly reviewing and tweaking your investment portfolio you can ensure that your money continues to work as hard as possible for you.
If you have any questions on this blog or any other financial matter please leave a comment or contact Savvy directly.