Building a Diversified Investment Portfolio is vital in reducing your risk in the event of unforeseen circumstances or a general market crash. As the saying goes, “Don’t put all your eggs in one basket” and it is true to how you should invest.
If you are investing with a suggested timeframe of at least 5 years in mind, it is highly likely your investments will experience some ups and downs along the way, and sometimes the downs can last for a very long time!
It’s a Balancing Act – Hopefully Tipping the Scales into Profit
Imagine you purchased shares in one of the UK-listed banks such as Lloyds Banking Group just prior to the Global Finance Crisis – trading as high as 310p at that point, and shortly after falling and never really recovering from around 70-30p per share.
You would be looking at a pretty upsetting loss.
Now let’s say you had a diversified portfolio and also invested in Halma PLC at roughly the same time before the Global Financial Crisis – buying at 200p a share. Whilst Lloyds Banking Group has never really recovered, Halma is trading as high as 2000p a share. Halma has ensured your diversified portfolio is overall returning a positive!
Lloyds Banking Group is in the Banking sector but Halma is in the business of ‘life-saving technology’ – selling products such as health monitors through to safety devices for people working with dangerous machinery. Two very different businesses, and two very different performance levels.
How Much is Too Much?
The principle can be extended further – if you are buying Equity Funds, you may look for UK and Global Equity Funds, likewise, you may not just want to be invested in Equities and seek Bond Funds to weather a storm and provide an Income.
There is so much debate as to how many of an asset you should hold in a well-diversified portfolio. Some would say a minimum of 10 shares, some say 40 and beyond!
But when you get into that territory, you are better off looking at funds that hold many large numbers of shares in a single fund! Ultimately it comes down to what you are comfortable with and can adequately monitor.
Obviously, the suggested number of funds to hold is smaller as the fund itself divests in many different assets (some funds can invest in up to 100 shares alone).
Diversifying your Portfolio
The logic of a Diversified Portfolio is clear. Now comes the time to actually build it.
The starting point is you – what is your attitude to risk? Are you looking for greater capital gains or income? How long are you planning to hold onto your investments? This will all influence the asset allocation – how much weight your investment will have to certain assets – e.g. Shares against Bonds.
In the case of a Fund it could be getting the balance between Corporate Bond Funds (Least Risky), Emerging Market Equity Funds (Most Risky), UK Equity Funds, and Global Equity Funds.
Having understood your personal circumstances, you are now in a better position to start diversifying your portfolio.
Here are some tips on how to do it:
- Invest in funds: Whilst you may have invested in a few shares that have caught your eye. Investing in funds is a quick and easy way to diversify. This is because funds will invest in many assets – usually up to around 100 per fund but you are just buying into one fund.
- Investing in different sectors: Applicable to both shares and funds. For example, if you are investing in shares, look at multiple sectors for example banking in the UK and technology in the US. If you are investing in funds, the same principle applies, for example investing in a Global Equity Fund as well as a UK Equity Fund (if you are firmly focused on Capital Growth).
- Investing in different asset classes: It’s not all about shares or equities – bonds, commodities, property, and cash there are so many to consider. Funds make it easier to invest in different asset classes.
- Multi-asset funds: These have diversification at their very core – investing in many different asset classes under one fund. They invest in multiple assets such as shares, bonds, cash, and property rather than just one type of asset such as shares.
- Re-balance your portfolio: Within your portfolio, it is likely some investments will do very well in comparison to others. This will in turn increase the weighting you have to them in your portfolio. Let’s say your investment in shares was doing well – the value of your portfolio may now be 80% shares and 20% bonds. However, you wanted an equal weighting as per your original asset allocation target – so you will look to sell some of your shares and buy bonds to bring it to a 50/50 weighting allocation.
Rule the Roost: Put a few Eggs in a few Baskets
If you are looking for a quick win, then investing in a handful of shares and taking a profit in the short run can be appealing, but it is not sustainable if you are investing for at least 5 years.
Building a diversified portfolio is hugely beneficial to you as an investor – it protects you from large falls in some investments (which can happen) by countering the fall with investments that perform better and hopefully deliver you a tidy profit.