What is diversification and why does it matter?

Diversification. The process to spread your money across a range of different investments, with the objective of limiting your exposure to one type of risk.

What does this mean?
Although a bit of a cliché, the saying ‘don’t put all your eggs in one basket’ is an analogy which explains diversification very well. Quite simply, holding all your money in one place could prove costly if that investment area suffers any negative impacts.

For example, during the ‘Dotcom Bubble’ in the 1990s, many investors directed large amounts of their money into Internet Stocks following a period of highly positive opinions towards online companies. In 2001/2002 that bubble burst and share prices for these types of Stocks tumbled. Investors who had focused on this area and had minimal diversification across their portfolios would have seen large losses.

Diversifying your portfolio can be done in a multitude of ways, such as spreading your investments across different types of assets. For example, your overall portfolio could consist of cash, equity funds, bonds and property. Each of these assets will have different levels of risk and their performance will differ from one another. 

Although the Stock Market saw large falls earlier this year, the Property Market has boomed. This is mostly due to the reduction in Stamp Duty Land Tax (SDLT) and pent up demand post lockdown. This illustrates that these two markets may not always correlate to each other which could help when looking to spread risk.

A further way to obtain diversification is by investing in different geographical locations. Assets in different places in the world are likely to be sensitive to different events. For example, you would expect US Stock Markets to be more affected by the recent US Election than German Stock Markets.

Some of the key benefits of diversification could include:

·         Reducing the overall volatility of your portfolio.

·         Providing some protection against large market falls.

·         Spreading the risk across your portfolio.

·         Providing different investment opportunities.

It’s important to remember that diversification will never be a silver bullet against risk. By nature, investing will always come with some degree of risk. However, diversifying your portfolio can help to spread and offset risk. Choosing the right investments for your portfolio will depend on:

• your attitude to risk, 

• the amount you wish to invest, 

• the length of time you are willing to invest for, and 

• your own financial objectives.

For further information on diversification or if you wish to discuss your financial arrangements in general, please contact me on 01206 217329 or trey.vella@birkettlong.co.uk.