Why diversify your investments?
Let’s start with an example of the opposite of diversification: Investing all your money in a certain type of technology. Let’s say jetpacks. We were all promised jetpacks. You’ve put all your money into a group of companies making jetpacks and parts for jetpacks. Then, it turns out jetpacks aren’t safe. There’s an accident. Stocks slide - nay, plummet - in jetpack companies. Suddenly, all of your investments have come crashing back to earth.
No-one is saying don’t invest in jetpacks - well, apart from those guys at Acme Balloon Co. - just don’t only invest in jetpacks. It’s not merely a matter of the actual things you invest in, it’s about having investments in different types of product. Some might be affected by the day to day shift of the markets, others by changes in interest rates or inflation. Others by a butterfly flapping its wings. But spreading your money across areas such as stocks, bonds, cash and funds means you’re more protected against market volatility. And that’s only the start - you can diversify in small and large companies, diversify globally - the wider you go, the less likely you are to lose it all on jetpack futures.
The joys of asset allocation.
Asset allocation is the action of divvying up your money. Think of it as your investment pick ‘n’ mix. With 50p to spend, how many cola bottles can you afford, and how many foam shrimp? And how many fizzy flying saucers are too many? Sorry, got carried away with the sweet metaphor there.
You’ll need to choose how many different assets you want to invest in, and the amount you’ll put into each one. This might be affected by a number of factors, and you may well feel that the time is right to put more in one asset than in another, as you may feel conditions are right for it to perform better. However, keep your eyes on the prize - lowering your exposure to risk while still making sure you get some returns. Qualified advice can help you to allocate your assets.
What asset classes are best for you?
What you choose to invest in may be largely led by how hands-on you want to be. The ultimate in simple one-step diversification would be to pick an index fund that tracks a particular stock market or several of them. That means you’re investing in thousands of companies. Alternatively, you might want to hand-pick a dozen bespoke shares to invest in - some people choose hundreds to really spread their risk. It’s up to you. In an ideal world, all of your investments offer a steady return, but the real world doesn’t behave like that. The more asset classes you have, the better the chance of certain ones balancing out problems with others.
Shares
Shares have their ups and downs - literally. While they can offer some of the best returns available, they’re also perhaps the riskiest type of investment. The prospects of a single company can be affected in numerous ways - by a drop in profits, by government regulation, by changes in leadership, by the wider economy and by investor sentiment. Prices can soar on good news, plunge on bad. By diversifying your share portfolio, you can inoculate yourself against some of this volatility. One more consideration, however: If you diversify into too many shares, will the dealing charges and costs eat into your returns? It’s a balancing act.
Funds
If you’re happy to have a fund manager do a lot of the heavy lifting for you, then a fund is a good way to diversify. They’ll take investments from a large number of individuals and split that pot across a portfolio of assets. You can study their past performance - the usual caveats apply - and the split of investments. Do they prefer emerging markets or the old reliable warhorses of the FTSE100? Does their approach align with yours? Where are all the jetpacks? Aside from the instant diversification this affords, the charges on funds are often less than having your own large share portfolio.
Cash
If you’re planning on having a thoroughly diversified investment portfolio, then cash has a role to play. But sticking it under the mattress isn’t going to help you. Cash is seen as safe - and held in reputable banks it certainly is - but the trade off is a poor long-term return, even with the benefits of compound interest. If inflation rates are higher than interest rates, your cash pot will fall in real terms. If interest is higher than inflation, will your cash savings be taxed? Despite these issues, it’s still a wise idea to have some cash for security, for emergencies, and for giving the kids pocket money.
Property
Property is a very attractive area for investments, but it comes with overheads. After all, if you want to invest in commercial property, you’ll need to manage your real estate to achieve the best returns. Whether you want a rental income from property you’ve invested in, or want to improve its capital value for a future sale, there’s work involved. You’ll also want to bear in mind the box ticking required in both purchasing and selling property, as well as the undeniable fact that it’s not the most liquid of investments - cashing in your holding can take time, during which the market can shift.
Bonds
Bonds - also known by the very sexy title ‘Fixed Interest Securities’ - are an investment stalwart. You invest in a company or government, and they promise to pay you back your capital after a fixed period. In the meantime, they pay you an interest rate on what you’ve loaned to them. Government bonds are seen as a secure investment, as default is relatively unlikely, but that means interest rates are lower. Company bonds carry more risk - what if they fold, or a bad run leaves them unable to repay their loans? - but returns are higher as a result. Inflation is another important factor here - your interest or ‘coupon’ payments are reduced when inflation is high. And that’s going to eat into your jetpack money.
Diversify today
How much you want to diversify will heavily depend on your attitude towards risk. If you want to play it even remotely safe, however, it’s a good idea to start looking at diversifying your investment portfolio straight away. Speak to the experts about ways to protect your investments from market volatility with a healthy spread, and about how many eggs and how many baskets you’ll need. Hmmm, maybe it’s time to move that jetpack money into basket bonds…
