With Easter fast approaching I’m looking forward to enjoying some chocolate eggs with my little one and the family. It got me thinking about the good old catchphrase of ‘don’t put all your eggs in one basket’ so I thought there would be no more apt time to put together a short blog on how this can be important when creating a financial plan or investment strategy…
With any investment, there is a risk that investments can fall as well as rise and whilst this cannot be entirely eradicated, diversification within an investment portfolio can help to reduce risk and volatility. Asset allocation is one of the most important decisions when constructing a portfolio, put simply it is spreading the risk of your investments, scattering your eggs in a mix of baskets!
So, what exactly is diversification?
Diversification involves investing in different areas or asset classes, with the aim of ensuring they have very limited correlation with each other. If all your assets reacted in the same way to the same news, then diversification would be pointless. It is important to remember, however, that there are two different types of risk, and diversification can only help to counter one.
Stock specific, or unsystematic risk –This relates to a company, asset or sector. An example of this would be a strike amongst a company’s employee’s or the possibility of poor earnings within a sector. This type of risk can be lessened through diversification of assets within an investment portfolio.
Market, or Systemic risk – This usually relates to events on a global level. These are generally the standard risks associated with investing. Examples of systematic risk are widespread inflation which can ripple out into the entire financial system. This type of risk is inherent within investments and cannot be reduced through diversification.
Types of diversification
There are many ways to diversify an investment portfolio and below are a few options that investors can consider as part of creating a financial plan…
- A combination of assets – mix up your chocolate
There are various assets in which you can invest, for example, equities, cash or fixed interest. You can also opt for more ‘Alternative’ asset classes such as Defined Returns and commodities i.e. gold or oil. To find out more about how Equilibrium combine different types of investments, take a look at our asset class overview here.
- Different sectors or companies – don’t stay loyal to one chocolate brand
Investment in a wide range of companies and industry sectors can potentially offer further diversification within asset classes. Change within some industries or sectors may have minimal effect on others so it is important to think about how you can spread your portfolio across different sectors e.g. investing in an umbrella company and an ice cream manufacturer. If you’re aiming for maximum diversification in a market you could consider a tracker fund, which would invest in each company in a specific index by its relative size. An alternative to this, or picking companies yourself, would be to use an active fund manager, whose job it is to pick and choose companies (albeit at an increased cost).
- Different regions – taste the world
Consider investing in different regions across the world which can further diversify a portfolio as certain markets may be more or less susceptible to broader risks, whether economic, political or natural. Allocating between developed markets, such as Europe, US and Japan, and emerging or frontier markets, such as India, China and Mexico would also provide a greater degree of diversification.
To find out more about how Equilibrium can help with diversification within an investment strategy and financial plan visit our investment management pages here.
The content contained in this blog represents the opinions of Equilibrium. The commentary in this blog in no way constitutes a solicitation of investment advice. It should not be relied upon in making investment decisions and is intended solely for the entertainment of the reader.