The importance of diversification

Putting all your money in one type of asset can be a risky strategy. You can help reduce that risk by ‘diversifying’ your assets, or in other words, spreading your money across a mix of investment types and countries.

As different assets and regions react differently to changes in political and economic conditions, this often improves the probability that poor returns from one or more investments are offset by the good performance of others. In turn, this helps improve the chances of more consistent returns over the longer term.

Diversification is an important fundamental principle to both those that are new to investing as well as the more experienced investor aiming to build a resilient investment portfolio.

The importance of diversification

One of the major aims of diversification is to construct a portfolio of investments that don’t all behave in exactly the same way. So while one part of your investment portfolio could be falling in value, the others may be flat or rising to balance it out. This difference in potential returns could offer some protection against all assets falling in value at the same time. Selecting the right mix can help to even out the damage inflicted by downturns, recessions or just routine fluctuations in specific markets. Different assets are affected by different factors: economics, interest rates, politics, conflicts, even weather events.
Markets are unpredictable and it will always be difficult to foresee what will happen in the future. It may be wise not to take a short-term outlook, and avoid overreacting to immediate stock market moves. Taking a multi-asset approach could help to smooth out your returns. A well-constructed investment portfolio, designed around your time frame and keeping your portfolio diversified could be a prudent way to weather market uncertainty.
Asset allocation refers to the decision of how much capital to invest and where, for example in stocks vs. bonds, in US vs. European stocks, how much to keep in cash and everything in between. Having the right balance - the optimal asset allocation - is what keeps you diversified in the market. Diversifying your investment portfolio across a range of asset classes, geographies and fund managers could help to reduce your overall risk.
If you need to protect yourself from the possibility of a short-term decline in the value of your portfolio, you are likely to follow the conventional wisdom of putting some of your capital into bonds rather than stocks. Whilst historically stocks have outperformed bonds over the long run, investing some of your money in bonds is likely to reduce the short-term ups and downs of your investment portfolio, which may allow you to sleep better at night.

Understanding Diversification Podcast

AXA IM Select’s Lorna Denny sat down with J.P. Morgan’s Vincent Juvyns to discuss diversification in relation to investments and how this can help investors keep a portfolio resilient during market ups and downs.

The third in our Investment Basics podcast series, it highlights some essential issues for consideration as well as providing investors with a helpful checklist.

 

 

The importance of diversification

The chart shows why it is so important to make sure your investments are diversified. As you can see, over time no single asset class or region is a consistent top performer. Spreading your investments across a range of asset classes and regions could help smooth the impact of ups and downs in the market. One investment may perform badly in any particular year but this negative performance could be offset by the positive performance of another investment.

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