Does diversification work?

Date Published: 31/05/2021 09:54

Financial planner Emma Baumback looks at the importance of diversifying your investment portfolio.

It has always been sound advice to diversify your investment portfolio – “Don’t put all your eggs in one basket” as the saying goes.

This can be done in many ways.  Investing into different asset classes, balancing out exposure to the stock markets with more ‘defensive’ investments such as bonds, cash and also property.  Another principle to the diversity rule is to spread your investments geographically – avoiding too much exposure with your portfolio invested in one country or region but, at the same time, giving yourself the opportunity to benefit from stock market returns in other parts of the world.

Of recent times, particularly in the light of the turbulence caused by the pandemic – some analysts have started to doubt this approach.  It is argued that all diversification does is guarantee that some part of your portfolio will make a loss. And should the early months of 2020 repeat themselves, all of your portfolio will make a loss. As one report suggested. “You can’t diversify your way out of a financial hurricane.”

Some investors may agree – the growing army of ‘Teslanaires’ (people who’ve done remarkably well out of Tesla shares) would be an example of the ‘just invest in one company’ approach. 

Although you will not be surprised to find out that there are flaws to this argument. For every Tesla there are a hundred companies where the share price goes in the opposite direction: but those stories rarely make common knowledge.

People who are saving and investing for the long term and who are not professional investors simply do not have the time or knowledge for such a narrow approach. What’s more, they like to sleep at night!

A diversified portfolio means always being unhappy with some component of your allocation. The purpose of diversification is to brace the unexpected market storms and there's no way to know when certain sectors, styles, or factors are going to outperform and for how long.

Holding such a wide range of investments provides a good chance that some part of your portfolio will be underperforming at any point in time.  But that is ok!

Each asset within your portfolio has a different job to do.  The goal of diversification isn't simply ‘the more the merrier’ – it’s a tried and tested strategy to help reduce the risk of significant loss during periods of underperforming markets.

Our philosophy here at Future Life Wealth Management Limited has always been to save and invest for the long term. To achieve your financial planning goals comes not from finding the needle in the haystack, but from working consistently and proactively with your financial planner to design a portfolio that matches your risk profile and your long-term objectives, and monitoring your portfolio regularly and consistently. 

Inevitably there will be good years and bad years but, over the longer term, that approach has always paid off.  

As you know, we’re absolutely committed to our clients and their financial planning requirements – and we’re absolutely committed to making sure they sleep through the night as well. Please do get in touch for a chat. 

No individual investment advice is given, nor intended to be given in this article and liability will be accepted in respect of any action you may take as a result of reading this article. If you are unsure you are urged to take independent investment advice.

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