Diversification is a key strategy for managing investment risk in unpredictable markets. By spreading your investments across different assets, sectors and regions, you can seek to protect your portfolio from volatility and enhance returns.
It is incredibly difficult to predict where financial markets are headed from day to day. Just because performance has not been good does not necessarily mean we are about to see an outsized rally. It also doesn’t mean we are about to see prices fall further either.
The stock and bond markets can be unpredictable and often lack a clear pattern. The task of forecasting prices is challenging due to a wide range of factors that influence performance, including political developments, the state of the global economy, unexpected events, and the financial performance of individual companies.
Investing can seem like a daunting prospect, especially when markets are so volatile. The good news is that there are things you can do to mitigate the risks and make things less stressful.
Why it pays to diversify
One of the biggest mistakes you can make when investing is to put all your eggs in one basket, as it leaves you vulnerable to market fluctuations. If you have invested solely in a single share and an unforeseen event occurs causing its value to plummet, your entire investment could vanish in an instant.
One way you can lower your risk without sacrificing your potential for higher returns is by spreading your money more widely – putting your eggs into lots of different baskets so it’s not concentrated in one place.
For example, if you invested 100% of your portfolio in shares and the market dropped 10%, you could see a year’s worth of growth wiped out overnight.
This approach is known as diversification and it helps mitigate the risk that all of your investments will experience the same negative impact at the same time.
Diversification helps mitigate this risk. By investing in assets that do not relate to each other, when one investment in your portfolio is underperforming, the others can make up for it.
Ideally, you should be looking to build a diverse portfolio with a mix of different investments in line with your attitude to risk. A balanced portfolio usually contains a mixture of shares, bonds, property and cash. Share prices will move up or down depending on how well companies perform, while bonds will be primarily influenced by interest rates. Property will also be influenced by interest rates and the strength of the economy.
Diversifying across assets can help manage risk by providing a buffer against unexpected events. Different assets tend to react differently to economic, political or market changes. For example, during economic downturns, bonds may offer relative stability while stocks may fall. By holding a mix of assets, you can potentially reduce the impact of adverse market conditions on your portfolio.
Invest in different sectors
Relying on investments solely within a single industry can leave you exposed to specific risks that could impact the value of your holdings. By investing in various sectors, you reduce the vulnerability to industry-specific factors that could adversely affect companies within that particular sector.
Factors such as new regulations, natural disasters, rising production costs or shifts in consumer preferences can have a profound impact on companies operating in the same industry. For example, if you had invested heavily in technology companies in the 1990s then your portfolio would have suffered when the dot.com bubble burst in 2000. If you hold investments in multiple companies within a single sector, the value of your investments may be disproportionately affected by these industry-specific risks.
Diversifying across sectors helps to mitigate such risks by spreading your investments across a broader range of industries. By doing so, you ensure that your portfolio is not excessively reliant on the performance of any one sector. Even if one sector faces challenges, the impact on your overall portfolio is minimised as other sectors may be performing well or experiencing less disruption.
Spread your investments globally
By investing in various markets globally, you can further safeguard your portfolio from economic issues specific to a particular country or region. Each country’s economy is influenced by its own set of factors, including political stability, regulatory environment, tax policies and macroeconomic conditions. By diversifying globally, you can reduce the risk of being exposed to a single country’s downturn or unfavourable events that may adversely impact its financial markets.
Spreading investments globally allows you to access a broader range of investment opportunities and potentially benefit from varying market conditions. Emerging markets, such as China, Brazil, and India, often present higher-growth potential but can also be more volatile than more established economies like the UK and the US. Investing in both emerging and developed markets provides the opportunity to balance risk and reward, capturing potential returns from different stages of economic development.
We’re here to help
One of the simplest ways to diversify your portfolio is to invest in a fund. A diversified fund offers the advantage of spreading your investment across a variety of assets. In the case of a managed fund, a skilled fund manager takes on the responsibility of selecting the appropriate investment options.
The purpose of a diversified fund is to mitigate the impact of a single company’s or sector’s performance on your overall returns. Depending on the fund’s risk rating and permissible assets, it adopts a comprehensive approach to diversification.
Wesleyan has an award-winning investments team, with fund managers looking after a range of diversified funds. Using our knowledge and expertise, we’re committed to getting the best returns possible while ensuring that investment remains simple for you.
Wherever you are on your investment journey, it’s never too late – or early – to seek financial advice from an expert. Speak to a Specialist Financial Adviser from Wesleyan Financial Services to see how our investment options could be used within your broader financial planning.
Remember the value of investments and any income can go down as well as up and you may get back less than you invest.