If you’re serious about building wealth, adopting a diversified investment strategy can be essential. It’s a simple concept, but one that many investors – including high earners – often get wrong.
Here, we are going to look at the basics of asset diversification and explain why it’s an important factor in any wealth management play. We will also explore considerations specific to high earners looking to diversify their portfolios more effectively.
What is asset diversification?
Asset diversification is the process of spreading your capital out over a range of different assets (or asset classes) in an effort to lower your overall investment risk and increase your potential returns. These could include equities, bonds, cash, and alternative assets. The aim is to reduce your exposure to individual assets, helping to mitigate the impact on your overall portfolio if certain asset classes underperform or deliver lower-than-expected returns over a given period.
Diversification does not eliminate investment risk entirely. However, it is a strategy that can support a more balanced approach to long-term investing.
Why asset diversification is important
Asset diversification can be important for a number of reasons.
Firstly, it can potentially lower your exposure to risk. If you own a properly diversified portfolio, you are unlikely to be impacted significantly if a few of your investments underperform over a short period of time.
It can also help to smooth out returns. Different asset classes tend to react differently to political and economic news and developments, and diversified portfolios tend to be less volatile than concentrated portfolios. Knowing that your portfolio is diversified – and that it is unlikely to suffer a major drawdown – can provide peace of mind, especially during periods of market turbulence.
A diversified portfolio could help reduce the impact of volatility and may offer more consistent returns over time compared to holding a single asset. While diversification does not guarantee better performance or eliminate risk, it can be recognised as a sound risk management strategy.
How to diversify your assets
A well-diversified portfolio will be diversified both across and within asset classes. So, at a headline level, you would expect to have exposure to all of the major asset classes, such as:
- Stocks
- Bonds
- Alternative assets
- Cash
But then you can also have diversification within these asset classes. For example, the stocks (equities) component of the portfolio can be diversified across sectors (Financials, Technology, Healthcare, etc.), geographies (UK, US, Europe, Asia, etc.), and market capitalisations (large cap, small cap, etc.).
Similarly, the bonds component of the portfolio can be diversified across different areas of the bond market such as government bonds, investment grade corporate bonds, and high-yield bonds. By diversifying, investors can potentially reduce overall portfolio risk and improve the resilience of their investment strategy in pursuit of long-term financial goals.
How correlation plays a role in asset diversification
An important concept when it comes to asset diversification is ‘correlation.’ This is a statistical measure that indicates how assets move in relation to each other. When assets move in the same direction at the same time, they are said to be positively correlated. Conversely, if one asset tends to move up when the other moves down, the two assets are said to be negatively correlated. By combining assets that have a low or negative correlation to each other (e.g. stocks and bonds), you can potentially lower your risk levels.
Asset allocation vs diversification
When building a portfolio, it’s important to distinguish between asset allocation and diversification:
- Asset allocation refers to how your capital is distributed across different investment types.
- Diversification involves spreading investments within and across asset classes to help manage risk, aiming to prevent any single investment from having a disproportionate impact on your overall portfolio.
Your goals, time horizon, and risk tolerance will determine your optimal asset allocation. For example, if you have a long-term investment horizon and a high tolerance for risk, you may consider investing more of your capital in higher-risk, (and potentially higher-reward) assets such as stocks. On the other hand, if you have a short-term time horizon and a low tolerance for risk, you may be better off focusing on lower-risk investments such as bonds and cash savings. If you're unsure about the right asset allocation, speaking with a wealth management expert can help.
It’s worth pointing out that asset allocation alone is not enough to effectively manage risk. After all, allocating 100% of your capital to one asset class won’t offer much protection if that asset class collapses in a market downturn. This is where asset diversification comes in.
How alternative assets can help investors diversify
Alternative assets are investments outside traditional asset classes such as stocks, bonds, and cash. They can include investments in commercial property, commodities, private equity, hedge funds, structured products, and other assets.
Alternatives can be useful from an asset diversification perspective because they often exhibit low correlation to traditional asset classes, which means they could help lower portfolio volatility. At the same time, they can offer investors new sources of return. By investing in alternative assets, investors can potentially create more balanced portfolios that may offer a more measured approach to risk and potential return.
Asset diversification tips for high earners
For high earners, portfolio diversification involves more than simply spreading investments across asset classes. It requires a considered approach that accounts for the unique composition of personal wealth, income structure, and long-term goals.
A common issue in this area is asset concentration. This is where a significant proportion of wealth is tied up in one area, such as company shares, business interests, or a single sector. This can unintentionally increase exposure to market-specific risk. For example, individuals that work for publicly traded companies often hold a large amount of company equity and may be overly reliant on a single asset or sector for their long-term wealth. Recognising these concentrations is often important when building a more resilient and diversified investment portfolio.
Another important consideration is human capital – the value of future earnings. While this asset is intangible, it’s often the single largest asset an individual has. Investing in assets that have a low correlation to their human capital could reduce risk levels.
Given the complexity of these decisions and the potential impact on long-term wealth, working with an experienced financial planner who understands the needs of high-net-worth investors is essential.
How Bowmore can help you diversify your assets
At Bowmore, we specialise in helping high earners build long-term, diversified investment portfolios as part of a broader wealth management strategy.
Whatever your reason for choosing to invest, we can help you build and maintain a well-diversified portfolio that is in line with your risk levels and designed to help you achieve your individual goals.
To find out more about how we can help you diversify your assets, get in touch here.
Regulatory Information
- Bowmore Financial Planning Ltd is authorised and regulated by the Financial Conduct Authority
- The value of your investments can go down as well as up, so you could get back less than you invested
- Past performance is not a guide to future performance
- The tax treatment of certain products depends on the individual circumstances of each client and may be subject to change in future.