While people might have an inkling of what the market might do at any given moment, nobody can be 100% certain. As a result, your investment strategy should always prioritise security to protect yourself against market crashes or downturns.
It doesn't matter how much confidence you, your friends, or your family might have in any given investment. Many financial professionals tell you that diversity is vital if you want to minimise risk in your portfolio.
Why Should You Diversify Your Portfolio?
You may have heard tales of people investing in one stock that saw a meteoric rise in a short space of time. While this is attractive, investment is rarely that simple. Furthermore, significant investment into just one stock or asset can be a risk.
Let’s say you’re a property developer looking to invest £5 million. You might find one house worth £4 million, on plenty of land, and you decide to buy it. You then invest another £1 million into a renovation and further development projects.
But during this development, you discover something is critically wrong with the property. Japanese knotweed might be infesting the property, or maybe the council is building a noisy bypass next door. Either scenario might lower the value of your investment significantly.
In this case, it might have been better to take that £5 million and spread it across, say, ten properties worth £500,000 each, or twenty worth £250,000 each. That way, even if you encounter issues with one property, you have several others that may continue to perform as good investments. Achieving this scenario is the main idea behind diversification.
What Are the Best Ways to Diversify Your Portfolio?
If you’re looking to diversify your portfolio, you might start by simply investing in a range of products.
This might mean that if you're trading stocks and shares, you choose a range of different companies, rather than just one or two. You might also consider investing in several sectors. If you only have investments in, say, oil and gas companies, this can be risky if fuel prices decrease. The more industries you invest in, the more protection you are likely to have from industry-specific dips and downturns.
When investing in stocks and shares, you can also look out for other benefits that individual investments might have, such as dividend payments.
At the same time, if you keep all your money in a single savings account, it might be worth spreading it around. As well as offering better interest rates, banks and building societies also provide a variety of services, including bonds and ISAs, for longer-term and lower-risk options. Banks are also protected by the Financial Services Compensation Scheme up to £85,000 if security is your primary concern.
You can also check in with your bank to see if they provide “investment accounts”, which often provide you with greater freedom to build your portfolio. This can be a great place to start for first-time investors.
Finally, there’s also the option of using managed funds, such as sector and real estate funds, unit trusts, and OEICs. The general principle with funds is that somebody else decides the investment direction. As a result, you get more diversity from the minute you invest, but less direct control over your investment. You won't be able to pick and choose which individual stocks and shares you want to invest in and follow.
What Should Your Portfolio Include?
A healthy investment portfolio often includes a variety of products spread across several industries and countries.
It might also include products with different risk profiles. A balance of low and medium-risk investments provides you with some security without compromising on potential growth. For instance, you may have 50% of your capital in savings accounts and ISAs, while the rest could spread across bonds, funds, shares, and maybe even property.
Most importantly, however, you must choose the products that are right for you. If you're somebody who wants to follow your money on a day-to-day basis, do some research and maybe even try a class so you can take a more active role in your investments. Online learning platforms like Udemy are great if you want to try a series of lessons. At the same time, comprehensive websites like Investopedia allow you to research at your own pace.
Conversely, if you’re not bothered and are happy to trust somebody else with the responsibility of your investments, funds might be the most suitable choice.
If you have your heart set on low-risk options, you can consider using more secure products like ISAs and bonds to see a slow but steady return on your money.
Can You Over-Diversify?
Yes. When it comes to your investment strategy, you might want to ask yourself if you’re spreading things too wide or too thin.
An over-diversified portfolio might be very secure against market downturns. Still, it can also be limited when it comes to growth. If you have too many investments, you may not be able to invest enough money into them to see a worthwhile return.
Over-diversification also often makes it more challenging to manage your portfolio in general. Every new investment you make increases the amount of administrative work involved in managing your money.
Some advice services recommend holding no more than 30 separate investments in stocks and shares. This figure comes down to around 15 or 20 if you’re using funds.
Other Things to Consider
There are other, less obvious ways to diversify your portfolio and help boost the overall security of your investments.
For instance, let's say you have paid off your mortgage. If you are considering downsizing, rather than moving house, you can look at the option of letting out your existing property and getting another, smaller mortgage elsewhere. This would also mean that you receive a sum of money every month in addition to other investments or pension payments.
For the technologically savvy, there’s also the option of using low-cost investment apps like Nutmeg, Wealthify, or Stash.
These platforms provide a variety of different benefits – Wealthify lets you invest with as little as £1, while Nutmeg offers fee-free investing – to suit different types of investor. Look around and find the app that works best for you.
Diversification is a simple concept, and it’s an important one to consider for your investment strategy. Furthermore, there are several ways you can increase diversity in your portfolio. With no single proven approach, you have the freedom to choose the options that work for you.