There are risks associated with investing which is one reason why many people might rather simply keep cash in a bank account. Yet there are ways to manage this risk whilst also taking advantage of the higher wealth potential involved with investing. One of the best ways to do this is by diversifying your portfolio.
This article by our Financial Planners offers some thoughts on how to do this. We hope you find this content useful and invite any questions you may have about how this could affect your financial plan, via:
t: 01228 210 137
What is diversification?
Quite simply, diversification involves spreading your investments across a range of different investment opportunities. Usually, this requires including a blend of ‘asset types’ within your portfolio – such as company stocks, bonds, cash and property. It also typically involves diversifying within these asset types too; for instance, by spreading your stock investments across multiple companies from different sectors/industries, at different sizes and stages in their business life cycle.
Why diversify?
Diversification isn’t primarily concerned with increasing your returns, but rather, its main aim is to protect your wealth as it grows and to mitigate investment risks. Let’s take one asset type as an example – shares (also known as ‘equities’). Between 2009 and January 2020, shares in the developed world generally enjoyed a near 11-year ‘bull run’ – i.e. steady ongoing growth. Of course, as we all know, the Covid-19 pandemic then hit and national lockdowns were enforced across the world, leading many shares to plummet in value as business activity ground to a halt.
Those investors who had portfolios consisting almost entirely of shares would have likely seen their portfolios plummet in value, especially those heavily invested in badly hit sectors such as aviation, hospitality and leisure. However, those with equity investments in companies which benefited during the lockdown (e.g. medical research, home gym equipment and gaming) may have fared better. Those with other asset types in their portfolio would have probably also been hit less hard, such as those with ‘safer’ fixed-income investments (e.g. UK government bonds).
How do I diversify properly?
This is the key question, of course. In particular, how do you strike the right balance with your diversified portfolio? After all, it is possible that too much diversification can lead to a portfolio which is too ‘thinly spread’, leading to eroded returns. Yet, on the other hand, our Financial Planners in Cumbria and Teesside also recommend not under-diversifying either, which could leave your portfolio over-exposed to unnecessarily exposed risks (e.g. market shocks).
Here, it’s important to state that every portfolio will need to be constructed differently depending on a range of important factors. These may include:
- Your investment horizon (e.g. how many years you have until you plan to retire).
- Your attitude to investment risk (e.g. cautious, adventurous or somewhere in between).
- Your interests/preferences (e.g. are you especially interested in property or startups?).
- Your financial goals (e.g. what kind of nest egg do you hope to build for retirement?).
For instance, suppose you are nearing retirement and have the primary goal of protecting the wealth you have carefully built up over many years of work. The last thing you want is a sudden market shock to eradicate 20% or more of your portfolio’s value. As such, an individual in this position might choose to weight their portfolio more heavily towards ‘less risky’ assets such as bonds and cash investments.
On the other hand, suppose that you are a 25-year-old professional. You have, potentially, over 40 years of work ahead of you. This investment horizon allows plenty of time to build up a decent pension pot and recover from any market shocks along the way. Consequently, this investor may wish to balance their portfolio more heavily towards shares – which are higher in risk, but which generally offer the chance of higher returns. Nonetheless, because this investor is still naturally quite a cautious person, they still choose to hold 10% of their portfolio in bonds and 10% in cash – just for peace of mind.
Conclusion and invitation
Crafting a properly balanced portfolio has enormous benefits which can reduce your risk exposure and help you engage with investment opportunities and growth which you may otherwise have missed out on. Not only will it be crucial to set everything up appropriately (e.g. in line with your goals and risk appetite), but ongoing monitoring will also be necessary. After all, as some investments grow and others perform differently, you may need to re-balance your portfolio once or twice per year to ensure that the balance still reflects your chosen asset allocation strategy over the years ahead.
If you want to start a conversation with us about your financial plan and investment strategy, then we would love to hear from you. Get in touch with your Financial Planner here at Vesta Wealth. Reach us via:
t: 01228 210 137
This content is for information purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice regarding your affairs please consult your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England. Note that the value of investments and the income from them call fall as well as rise.