What is diversification?

Your brief guide to investment diversification


What is investment portfolio diversification?

At Wesleyan, our funds are managed for the long term and have diversified portfolios to help with that aim. But what is a diversified portfolio?

When you diversify your investment portfolio, you are spreading the risk associated with your holdings. This can be done in various ways; for example, investing across a broad spectrum of asset classes or business sectors.

Consider the saying, 'don't put all your eggs in one basket'. In this scenario, if the basket gets dropped, there's a chance all the eggs will be broken. This wisdom can be applied to investing. If you concentrate on one stock or asset class and it performs badly, you may lose more money than you would have done through spreading your investment.

A diversified portfolio can therefore be a better investment choice that offers more protections and potential for financial returns. By placing your eggs in different baskets, if one stock falls, you're less likely to be left with a handful of broken shells.

How can you diversify your investments?

One of the simplest ways to diversify a portfolio is to invest in a fund. A diversified fund provides an opportunity to spread your investment across a range of assets. If it's a managed fund, there'll be a dedicated fund manager responsible for choosing where to invest.

To try and limit the impact of one company or one sector's performance on your returns, a diversified fund will take a more holistic approach, depending on its risk rating and the assets it can hold. A multi-asset fund can be diversified through a blend of the following:

  • Different asset classes – An asset class is a group of similar investments. Bonds, stocks and property are all examples of asset classes.
  • Different business sectors – For example, the financial sector, food, construction or retail.
  • Regions – A fund manager may choose to invest across different countries to help spread the risk between different economies.

Risk varies from one asset class to the next. For instance, bonds have traditionally been considered a lower risk investment than stocks. The same principle of varying risk can be applied to business sectors.

How does an investment fund work?

An investment fund is often a simple way to undertake portfolio diversification. It works by pooling your money with that of other investors to buy a range of assets. These will typically come from different asset classes, business sectors and companies. A fund manager makes the decisions on where and when to invest on behalf of the members.

The fund is divided into units of equal value. Instead of owning the assets being invested in, you own a share of the units. The amount of units owned is relative to your personal investment. Their value is tied to the performance of the fund's underlying assets.

Different investment funds come with different levels of risk. From minimal risk, made up of assets that undergo little change in value on a day-to-day basis, through to high risk, where the daily value of the assets has a tendency to fluctuate significantly. You should consider carefully the amount of risk you are prepared to take with your money.

Although some funds target specific sectors or countries, for investment diversification purposes it's best to pick one that has a varied range of assets in its portfolio, chosen according to your appetite for risk.

What are the benefits of diversification?

Here are some of the key potential benefits:

  • Risk reduction – Asset diversification can reduce the chance of overall loss by spreading the risk. It means your return is not dependent on the performance of a single asset.
  • Market exposure – You can get exposure to different markets, the cyclical nature of which means that if one is suffering a downturn, others might be on the rise. Diversification increases the chance of always having a stake in a leading market.
  • Peace of mind – The potential stability of diversified investment eases the pressure of selecting just one or two successes. This can mean a less stressful path to achieving your investment goals.

Are there any disadvantages of a diversified portfolio?

If you’re not investing in a managed fund, then diversification can be challenging:

  • It generally requires a lot of experience and can be time-consuming, particularly keeping on track with the movements of different assets; this is a key reason why many people choose to invest in a diversified fund that is managed on their behalf
  • Transactional and managerial fees can result in higher costs, due to the number of assets involved
  • Returns may not be as high as they could be if risking it all on a single asset, if that asset performs very well.

Diversification doesn't eliminate all risk. Financial crashes and other global events can sometimes affect all investments at once. Such occurrences tend to be the exception rather than the rule though. Diversification, which is made simpler via a professionally-managed diversified fund, is therefore generally a less risky option than not diversifying investments at all.

Making diversification simple

A diversified investment fund, with a dedicated fund manager, can be the wiser option if you are inexperienced when it comes to investing. It could also be a convenient choice if you lack the time or the will to keep on top of a wide range of holdings.

Wesleyan has an award-winning investments team, with fund managers looking after a range of diversified funds. Using their knowledge and expertise they are committed to getting the best possible returns, while ensuring 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. Wesleyan Financial Services is here to offer guidance when you need it.

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