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Why diversification is important for investors – and a simple way to achieve it

A well-diversified portfolio, where constituents perform differently rather than moving mostly in tandem, is a simple concept but not necessarily easy to achieve.

| 6 min read

Diversification means using a range of investments with different characteristics in order to help counter risk. All investors should diversify to some degree. To take an extreme example, investing in the shares of just one company could put you in a poor position if things take a turn for the worse in that business.

Diversification by sector, geography and type of asset can help reduce risk in an investment portfolio and ensure you are not overly reliant on one area or on certain economic circumstances. If one of the investments is performing poorly another could be making up for it, meaning a less bumpy ride for your portfolio overall. Over the long term each can still contribute towards performance – assuming they are well chosen – thereby improving the return achievable for a given level of risk.

Simple but not easy

A well-diversified portfolio, where constituents perform differently rather than moving mostly in tandem, is a simple concept but not necessarily an easy thing to achieve. Sometimes assets that appear to be different can end up being aligned to some of the same trends. Although equities have historically provided the best returns over long periods (five years plus), using other assets such as bonds, property and alternative investments can reduce risk while still generating decent performance over the long term. It is also worth rebalancing a portfolio periodically so that the different elements don’t stray too far from the intended proportions.

Getting a portfolio balance right can take some consideration and depends on a number of factors – investment goals, timescale and the requirement for income. It will also be shaped by how much volatility (the extent of ups and downs) you are prepared to accept – and this could change over time. Take too little risk and your capital may not grow as much as you need it to; for instance, having a large weighting to low risk areas in your pension in your twenties and thirties would seem a wasted opportunity. However, take too much and you could become a victim of market volatility at just the wrong moment. This is particularly relevant for investors looking to cash in or draw upon their investments in the shorter term.

What are the options?

There are two main options for building a portfolio – ‘Do It Yourself’ or using the expertise of professionals. Diversifying a portfolio yourself puts you in control and can potentially reduce costs, especially if you use predominantly low cost ‘passive’ investments designed to replicate returns from a certain benchmark index. If you are a more confident investor but in need of ideas, our Foundation Fundlist may be worth a look. Selected by Charles Stanley’s Collectives Research Team, this highlights what we consider to be good-quality options for new investment in each of the major sectors.

However, the DIY route does mean dedicating a certain amount of time and effort into researching and monitoring investments, especially if you buy actively-managed funds whose fund manager, style and relative performance could change over time. For some this research is enjoyable, for others a chore. An alternative – if you have a good idea of the amount of risk you want to take but feel you don’t need full financial advice or wealth management – are multi asset funds. These aim to offer investors a broad and balanced portfolio in a single product, meaning regular monitoring and re-adjustment of individual funds, trusts, shares and other assets in the portfolio is taken care of for you.

For many less hands-on investors, multi asset funds can be convenient and provide instant diversification. However, the level of risk taken with multi-asset funds varies, so investors need to be careful they select an appropriate one for their needs. In the case of ‘actively’ managed funds, a further advantage is that a professional team is continually re-evaluating, rebalancing and optimising asset allocation according to their views. Meanwhile, passive multi asset funds typically just rebalance to prevent asset allocation getting out of kilter. Most multi asset funds also allow you to invest with small amounts that would otherwise mean diversification is difficult to achieve.

‘One-stop-shop’ portfolios

Our own Multi Asset funds are monitored and rebalanced by Charles Stanley’s experts, each offering a diversified portfolio in one easy-to-buy investment while keeping to a chosen level of risk. The funds invest in a variety of shares and bonds identified from Charles Stanley’s equity and fixed income research, as well as funds. Allocation between different areas is shaped by the economic views of the team, with portfolios reviewed on an ongoing basis with changes made when deemed necessary and to react to new opportunities.

The costs can be higher for actively-managed multi asset funds. That’s because there are fees for some of the underlying investments on top of the fund charges themselves. However, our range represents excellent value with annual management charges cut to 0.3% earlier this year. That’s less than half the cost of some of the well-known actively-managed competitors.

One size cannot fit all so these funds are not necessarily a perfect solution. Yet for those who want a straightforward, low cost and comprehensive product – and to avoid the work involved in putting together, monitoring and rebalancing a portfolio of different individual investments – they could be worth considering. Alternatively, they can help make up a ‘core’ of a portfolio around which other investments can be added.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

Why diversification is important for investors – and a simple way to achieve it

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