Page 44 - DIY Investor Magazine | Issue 40

INVESTING BASICS: USING DIVERSIFICATION TO DEFEND YOUR INVESTMENTS
April 2024 44
DIY Investor Magazine ·
There’s no single winning formula to being a successful investor, but experts agree that maintaining a diversified portfolio is essential – writes Christian Leeming
By owning a variety of asset classes, each of which behaves differently during market ups and downs, it’s possible to create a portfolio that can minimise risk and smooth out returns, particularly over a long-term investment horizon.
THE BENEFIT OF MIXING UP THE ASSET CLASSES
Diversification is crucial whatever your circumstances or attitude to risk, to protect your savings from market shocks.
Investors need a basket of uncorrelated assets so that if one asset class does badly, those doing well balance it out; good diversification helps investors avoid the worst financial markets ups and downs.
A diversified portfolio could contain a blend of equities, bonds, cash, and alternative asset classes such as property, to benefit from their different investment cycles.
It should be diversified geographically as well as in different asset classes; world markets do not all perform in the same way at the same time, and there are global funds to choose from that invest in companies listed on overseas markets, where economic and profit growth may be higher than the UK.
ADD DEPTH WHEN DIVERSIFYING
Investors should also consider diversifying across investment styles – such as value and growth.
Value investors seek stocks trading at a significant discount to their intrinsic value; many fund managers buy unloved stocks in which they see potential.
Growth investors seek rapidly expanding companies that look set to significantly grow their earnings over time, reinvesting in their business rather than paying out profits to shareholders. Diversify within sectors too.
Examples of sectors include technology, healthcare, utilities, construction, financials and mining. Within these sectors investors should aim to own small-cap, mid-cap, and large-cap stocks.
If you are dependent on income from your investments, it is essential to have a mixture of investments from which the income is derived.
MAKE SURE YOU AVOID DUPLICATION
A common mistake is believing that buying a range of funds in the same style – such as equity income funds – delivers a diversified portfolio.
In fact many contain the same stocks – such as Vodafone, GlaxoSmithKline and Royal Dutch Shell – which means there’s duplication rather than diversification.
A wider spread of holdings and therefore a wider spread of risk can be had by buying several different types of funds with exposure to different asset classes, sectors and also different countries.
Investors have more choices about where to put their money than ever before, but it can also be a mistake to over-diversify and end up holding so many different asset classes or funds that you end up with a pseudo tracker-style fund without the normal cost savings.
Diversification cannot guarantee gains, or that you won’t experience a loss in volatile markets, but it is the one of the most sensible ways to spread risk over the long term.
Investors who want a helping hand with diversification can consider buying a multi-asset fund. The fund manager will pick the best funds from each sector, investing in a wide range of assets and securities as an additional way to diversify and spread risk.
Check the levels of diversification of your investments regularly to ensure you avoid any nasty surprises from overexposure.