What is diversification and why does it matter for my investment portfolio?

Businessman dressed in suit and tie puts one golden egg into three separate baskets.

Diversification is jargon for “don’t put all of your eggs in one basket”.

Holding a well-diversified portfolio can help you minimise your risks whilst at the same time maximising long-term growth potential.

Most investment managers agree that whilst a well-diversified portfolio doesn’t give you guaranteed downside protection it is indeed one of the most important aspects that will help you meet your long-term investment objectives.

Variety can pay over the long term

In essence, a well-diversified portfolio aims to reduce the volatility of your investment portfolio.

Investing all your money in a small number of companies (single stock) carries an extremely high level of risk because one bit of bad news (e.g. lower than expected sales, regulatory changes, natural disaster, change in trends) in relation to a particular company can cause its share price to tumble.

Investing your money across a range of different investments means that if one performs badly, others may do well, which significantly improves your chances of increasing the value of your investments over time.

How to diversify your portfolio

To create a well-diversified portfolio, you need to spread your money across a range of different assets. Retail investors typically have three asset classes available to them for investment: Equities, Fixed Interest and Alternatives.*

It is widely accepted that asset allocation is responsible for between 80 and 90% of investment returns, so getting this bit right is a key factor to a successful investment strategy. Part and parcel of this is diversification within these different asset classes.

For example, within the equity space you can diversify across specific regions, sectors, themes and even company size:

  • Geographical regions – US, UK, Europe, Asia, Japan and so on
  • Sectors – Finance, energy, transport, consumer discretionary etc.
  • Themes – Technology, healthcare, renewable energy
  • Size – smaller companies (small cap) or larger companies (large cap).

However, diversification doesn’t stop there.

To ensure you optimise the diversifications of your investment portfolio you can then use investment funds to actually diversify within the specific regions, sectors and themes.

To give you some perspective, a Balanced Bowmore investment portfolio investing across the three major asset classes and underlying regions/sectors/themes has exposure to approximately 1,700 underlying companies and holdings.

January 2022 proves the importance of holding a well-diversified portfolio

During the month of January, US markets, US tech markets, UK smaller companies (FTSE 250) and Japanese markets among others, entered correction territory (down -10% peak to trough). In fact, January 2022 was the worst January on record for over a decade.

Tech-heavy portfolios took a bit of a thrashing

If you had a technology heavy portfolio during the month of January, you would have experienced a painful shock. During the month, the US tech index (Nasdaq) was at times, down more than 15%.

Companies such as Netflix plunged when the TV streaming service reported lower than projected subscriber additions for the last quarter of 2021, falling nearly 20% in a single day. Since early November 2021, Netflix stock has dropped by almost 45%. This is just one example of numerous tech casualties during the January sell offs.

Returning to the theme of diversification, holding purely tech has offered little downside protection over recent months. But many other sectors have fared much better, and some are even in positive territory (commodities as a good example).

Diversification not only helps you achieve more consistent investment outcomes, but also irons out the bumps in the road that often cause setbacks that can wipe out years of positive returns.

As illustrated in the chart below, world equity markets were significantly lower at the end of January than they were at the beginning of the year. However, by holding a well-diversified portfolio you would not have participated in the majority of the downside that some of the individual markets experienced.

 

 

 

Get in touch

Bowmore Asset Management specialise in building and managing investment portfolios for private clients, trusts and charities. We invest across all major asset classes, including equities, fixed interest, hedge funds, commodities and property funds.

Our primary aim is to help you achieve your investment goals.

If you want to ensure that your investment portfolio is well-diversified and balanced according to your financial goals and appetite for risk, get in touch.

Email enquiries@bowmoream.com or call us on 0203 617 9206.

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.

Bowmore Asset Management Ltd is authorised and regulated by the FCA.

*Alternatives

Exposure to the following types of investment:

  • Hedge Funds – funds of funds or individual hedge funds listed and regulated in the UK
  • Commodities – exposure to gold, oil and other commodities, either via a collective fund or a fund that tracks the price of an individual commodity or basket of commodities
  • Property – mainly via collective investments that are listed in the UK and have exposure to both UK and Global Property
  • Multi-asset class – exposure via collective investment funds that will invest in many different types of asset including all of those listed above and possibly others
  • Structured products – these are investments that are linked to a particular stock market and offer the potential, but not a guarantee, of some capital protection depending on how the investment is set up

Equities

Exposure to UK and global stock market investments, ranging from UK companies to Far East and Emerging Market companies.

Fixed Interest

Exposure to government debt (Gilts), both inflation-linked and paying fixed annual payments (yield). As well as exposure to corporate bonds (debt) issued by companies, both in the UK and globally.