Diversification means spreading your money across different investments to balance the level of risk in your portfolio.
- In different assets, sectors and regions
- With different risk exposures
- That tend to move in different directions.
To protect your portfolio from:
- A sudden drop in the value of a single investment, or group of related investments
- The disproportionate effect of a poorly performing investment
- Unpredictable events in a sector or region.
So a weak returning investment shouldn’t affect your portfolio’s overall performance too much as your stronger returning investments will ideally make up for it. Of course, even well-diversified portfolios are at risk from market movements and you could still lose money.
All investments can fall as well as rise in value, and the value of international investments may also be affected by currency fluctuations. But you can try to achieve more balanced returns – both gains and losses - by diversifying your portfolio.
A diversified portfolio is typically split across a range of different asset classes, with exposure to different companies, industries and types of market from different regions around the world. For example:
An undiversified portfolio is typically too heavily focused on a limited number of asset classes which provide exposure to a much smaller range companies, industries, market types and regions. For example:
Ways to diversify
Split your investments between shares and bonds which don’t always move in the same direction.
Consider investing globally so a crisis in one country or region won’t affect your portfolio’s overall performance too much.
Remember, the value of international investments may also be affected by currency fluctuations.
Type of market
Consider investing in developed and emerging markets to balance risk, but add longer term growth potential to your portfolio.
Industry and sector
Look at investing in industries and sectors which react differently to economic forces.
Think about investing in large, medium-sized and smaller companies which may perform in different ways.
Shortcut to diversification
Funds and Exchange Traded Funds (ETFs) can provide the quickest shortcut to a diversified portfolio.
They make it easy for investors to build a diversified portfolio by reducing the volatility and potential gains and losses associated with holding individual shares.
A typical fund may hold perhaps 30 or 40 shares from different sectors and geographies. While a typical ETF replicates everything that appears in the index it tracks.
However, as many funds and ETFs tend to focus on a single country or sector, a well diversified portfolio might include a number of different funds or ETFs to provide asset class, regional, and sector diversification.
The sectors mentioned here are not a recommendation to invest. They are for example purposes only.
The value of investments can fall as well as rise and you could get back less than you invest. If you’re not sure about investing, seek independent advice.
Ready to start investing?
Get started with Smart Investor and enjoy a cutting-edge service that makes investing easy.
Interested in learning more?
If you enjoyed this article and want to hear more on our latest news, views and opinions then you can sign up to receive our regular email updates.