Diversification, diversification, diversification
Written by Paul Dodd on January 27, 2016.
Location, location, location is a well-used phrase in property circles and I’d like to propose a similar mantra with regard to investment: diversification, diversification, diversification.
A well-diversified portfolio is absolutely key to successful investment. If you haven’t come across the phrase before, it is really very simple. Assets come in the form of equities or shares, bonds, cash, property and commodities. If you have money to invest, you are better off buying into a variety of these asset classes rather than, to coin another well-known phrase, putting all your eggs in one basket. In fact, many experts claim that how you choose to allocate your assets is a much more important determining factor influencing returns than your choice of specific stocks or funds, and research seems to back this up.
The main reason this is the case is that asset allocation balances risk because different assets will react differently to various economic conditions. Ask anyone who had all their money in shares in 2007 just before the financial crisis and they could tell you a thing or two about the dangers of not diversifying. With a diversified portfolio investors can balance out the losses and gains of different asset classes and this is the best way to protect your investments. Obviously, you can then diversify further within each asset class, for example by selecting shares in different geographical areas or choosing bonds which mature at different times.
In the hierarchy of risk, stocks come top offering greater potential for reward but at a price. Bonds are a less volatile investment choice but offer more modest returns while cash is the safest option but offering paltry returns by comparison, especially in the current financial environment with interest rates still lingering at record lows.
Assessing your tolerance to risk is key when deciding on the allocation of your assets. If time is on your side and you don’t mind exposing your investments to risk, you could invest more in shares such as trackers which offer a greater potential upside but little protection against the downside. Over the long term, if you stay invested and avoid panic-selling, any losses are likely to turn out to be a mere blip in the upward trajectory of your investments. However, if your investment goals are shorter term – perhaps retirement is approaching or your child is coming up to university age and high tuition fees are looming – then you don’t have time to recover from the hit of a loss and need to be more cautious in your approach.
Investing doesn’t need to be complicated and it is of course possible for you to achieve a balanced portfolio on your own. However, if you feel you need some assistance, a professional financial adviser can be invaluable in helping you to clarify your financial goals and work out the best asset allocation to attain them within your individual parameters of risk.
The stock market has been riding high in recent years and many analysts believe a correction is just round the corner but the fact is that none of us has a crystal ball and it is very difficult to predict what will happen over the course of 2015, let alone further into the future. Whether you go it alone or choose to take financial advice, I urge you to safeguard your investments by adhering to my mantra of diversification, diversification, diversification.