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Investing can be a great way to meet your long-term financial goals that would otherwise be out of reach. While those large payouts can be enticing, it’s important to keep a level head, and be smart about your investments to manage risk effectively.
While risk is unavoidable, there are ways to minimise the risk you take when investing. One of the best ways to maximise your earning potential while keeping the risk at arms length is to diversify your investments.
Unless you’re a seasoned investor it’s unlikely you’ve heard of this technique. However, diversifying your portfolio is an essential requirement to thrive in the world of investing.
‘Diversified investing’ is spreading the risk of your investments across different asset classes, regions and markets to earn the highest returns for the least risk. By building a portfolio that is built with being dynamic in mind, you’re able to avoid your entire investment portfolio falling through.
This is due to the fact that different assets, regions and markets will react differently to the same economic events. While one of your assets in a specific market may have suffered a massive loss, that of a polar opposite market may have seen a peak.
By diversifying your investments you’re able to smooth out the peaks and troughs of your returns, compensate for the volatility of the market, and slowly but surely build a strong portfolio that is sure to pay off in the long run.
The first way we’re going to talk about is spreading your investments over different asset classes. This is the most basic means of diversifying your investments and should be heavily considered as a starting point.
By diversifying your investments across numerous assets allows you to benefit from long-term investments such as stocks and regular income like property.
This helps you in the moment with monthly returns that can also be used to invest, as well as keeping the end goal of long term investments in mind.
Stocks or ‘equities’ are essentially a share in a business. You can either do this independently or through an investment fund where your money gets thrown in with other peoples.
Investing in a single company has its risks which is why it’s important if you are going to invest independently you diversify your other investments across multiple sectors and locations.
Investments funds are lower risk because they provide more diversification, but risk is still varied.
Owning a diversified portfolio allows you exposure to a wide range of locations, maturities and durations. The goal of investing is to create a credible long term strategy that is stable and will ‘weather the storm’.
Diversifying your stocks allows you to do just that. However, bonds are different to stocks as they come with different risks which can be managed properly given the right research.
When speaking about ‘bonds’ there is a term called ‘Default Risk’ which as the name implies refers to the bond issuer defaulting and not making regular payments.
Diversifying isn’t as important when it comes to bonds, as it’s a simple case of ensuring that they are able to make monthly payments.
However, ‘Interest Risk’ refers to the risk that comes with the movement of interest rates over time. When you buy a bond, those payments are already determined, however, the amount that people are willing to pay for those bounds is constantly moving.
The reason that diversification isn’t as important when it comes to bonds is because changes within a specific market or country seem to correlate with the rest of the market.
While changes are usually expected to work in perfect harmony with the rest of the market, this isn’t always the case and your portfolio can be moved around to take advantage of these said changes.
Diversifying your property investments can make for a strong portfolio, due to the many ways you can vary investing in property.
The simplest of them all is the idea that the more properties you have the less risk is associated. Having more properties means spreading your risk across numerous assets, this is because you have more renters making for a more reliable income stream.
As with other assets the same advice can be taken, diversifying across different regions can make a huge difference for your portfolio. Different geographical locations perform drastically differently based on numerous external factors, so spreading your assets across regions can work in your favour.
The last way to spread the risk even further is to invest across different means of property. And by that we mean, the student accommodation market will perform much differently to that of buy to lets, commercial properties etc.
Diversifying your investments across different assets isn’t the only way to spread the risk. There are numerous other methods to protect the overall performance of your portfolio.
By diversifying your investments not only by assets but other by means you’re ensuring the survival of your portfolio despite ongoing factors. The more varied your investments can be, the better!
It’s alright to invest in a number of different asset classes, stocks, bonds, property, cash. But if all of your investments happen to be in the property sector and the property market crashes, there is not one of your assets that will back you up.
It’s important to diversify your assets across different sectors, even complete opposite sectors so that when one sector is suffering the other is unaffected or benefits. This way your overall portfolio will maintain stability because where one drops, another one will rise.
Another means of diversification is by location. If you concentrate all your efforts on a specific country or region and their government or market crashes, creating a recession then all your bonds, stocks, property will see a dramatic drop.
You can counteract this by spreading your investments across different locations, have some property in Paris, stocks in Germany, bonds in the UK. The more diverse you can get, the less you run the risk of your portfolio underperforming.
Of course to diversify your assets you first need to build a strong portfolio. One of the best ways to do so is to invest the same amount on a regular basis. By doing so you’re working to smooth out the volatility of the market.
This is conducted through a technique called ‘Pound Cost Averaging’. This technique essentially works in your favour to buy more shares when share prices are lower and buy less shares when share prices are higher.
This is a means of building your portfolio continually and reliably, while maximising your spend and return on investment.
The only way to build your portfolio is to get started and just go for it! You can’t diversify a portfolio that is too small or doesn’t exist.
While the point of our guide is to advise people to diversify their investments, there is such a thing of over diversifying. Spreading your investments across too many assets can actually become a hindrance rather than crutch.
First of all you have to consider if you have the budget to undertake diversification of your portfolio. Unless you have a considerable amount to investment and spread, you can run the risk of putting too little in each.
This while protecting you against the volatility of the market can actually cause your investments to be so little that they’re not able to generate enough return on investment, barely keeping ahead of inflation – if that!
Depending on your budget we’d recommend no more than 20-30 different assets in your portfolio, this minimises the risk of not generating a return. Having a lower but still diverse number of assets also allows you to keep an eye on your investments more closely and monitor their performance.
Investing can be a tricky game, there’s a fine line between under-diversifying, over-diversifying and also pulling out too quickly or too slowly. The point you’re waiting for is for the bond to ‘mature’ and stocks to grow over time, however investments can go sour and it’s important to know when to get out.
The property market for example, prices can fluctuate constantly, and it’s difficult to know when to call it a day. Here are some reasons you should consider getting out:
While poor performance is just part of playing the game, it’s important to understand the tell tale signs of what is a passing phase and what is going to be detrimental to your portfolio.
You should look at your investment and the whole of the market to get a full picture. If the market is under-performing then you can just accept that it’s due to the unpredictability of investing. However, if the rest of the market is performing well, but your stock is performing badly and has been for a long period of time it could be time to count your losses.
The opposite of the latter, your investment could be performing exceptionally well and has seen a significant peak. While this may seem like a great opportunity to hold out and see if it grows more, it also could be a temporary peak.
It’s important not to be greedy when investing and know when to call it a day. If one of your investments provides a significant return, then it may be worth considering selling and walking away.
If you’ve got a nice split between equity and bonds, fantastic – you’re doing a good job. It’s when your investments start over performing or underperforming that you would then need to sell to either cut your losses or maximise your gains.
While this doesn’t sound like a massive issue, it can throw your balance of investment of different assets, sectors and countries off kilter. To survive the volatility of the market your investments need to be diverse – if this balance has changed it may be time to reconsider where your investments are.
When you’ve built up the money you need, whether a retirement goal or a child’s education fund then it’s most likely time to get out. If you’ve met your money goals then there’s no need to push your luck.
Investing can be fun, educational and rewarding given the right strategy. Diversifying your investments makes sure even when you’re not winning, you’re still winning.
If you’re looking for quick bits of advice to start your investment journey, we’ve provided some diversification tips for you to consider when investing:
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Please note that nothing on this website, including the information about risks below, constitutes financial advice. You may wish to seek your own advice from an Independent Financial Adviser before you invest.
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