Investment diversification

A word which seems so simple, a concept that many think they can easily master, but do you fully appreciate what diversification means? If you check the meaning of diversification, you would find that in business terms it is usually the act of varying the range of products or services offered, or broadening the field of operations. In investment terms it has a similar meaning. Diversification involves spreading your money across different assets and asset categories.

Most of the time when people tell me that they are investing and I ask them if they have Investment diversification, I am met with a resounding “Yes, of course”. They then might go on to explain what they invested in and it is usually things which they would have come across on social media or heard about from another “investor”. These portfolios might comprise shares in a few US companies, a couple of US bonds and possibly some cryptocurrency for a touch of risk. Such a portfolio would seem OK to someone who had just begun investing some spare cash, but is it diversified?

Such a portfolio is not really diversified at all, and I will explain why. Starting off with the first part which is an investment in a few different shares. Firstly, they are all from one geographical region, meaning if something dramatic happened in US stock-markets, they would probably all be affected to some extent. Secondly, inexperienced investors often buy shares based on something they have read online or something they have heard from a friend or colleague. These investments are typically in growth stocks, in other words shares in companies which are perceived to have strong earnings potential and growth prospects, but often with a correspondingly high share price. Investing exclusively in this type of company may prove successful but also carries significant risk, as the expectation of highly profitable growth (sometimes reflected in an inflated share price) may not be realised for many years, if at all. This is why it is sometimes sensible to include more mature company shares in a portfolio, or possibly shares in a company paying good and sustainable dividends.

Moving on to the bond part of the portfolio, often this would be one or two bonds issued by the US government, maturing in say 10 years. It might also include a corporate bond to add a little bit of diversification. But how much attention has been given to the financial strength of the company issuing the bond or the bond’s yield to maturity (how much is received in regular income up to the date the bond matures). These are just a couple of basic questions that should be asked when considering direct investment in a corporate bond.

This brings us to the cryptocurrency portion of the portfolio, often consisting of holdings in popular names such as Bitcoin or Ethereum, or in a new ‘crypto’ trending online. Although I have nothing against a small allocation to cryptocurrency, it should always be treated as speculative with the likelihood of volatility and a high risk of capital loss. I sometimes question whether people investing in cryptocurrency understand the basics of this asset class, including its regulatory status and its ability to function as a currency. To read more about cryptocurrency – click here

One question all investors should be asking about diversification is how to achieve maximum returns with minimum risk. Or, put another way, how to make the most of their money without jeopardising their financial security. A well-diversified portfolio should include exposure to a range of asset classes, for example shares, bonds, property, commodities and cash. Investments should also not be restricted to a single country or geographic region, nor to a single theme or economic sector.

In practice, most people do not have the time or knowledge required to build a well-diversified portfolio which achieves the right balance between risk and reward, between capital growth and capital preservation. At Spectrum, on behalf of our clients, we therefore focus on identifying professional investment managers who specialise in maximising returns from efficient portfolio diversification.

If you have any questions regarding asset diversification and investment returns, our advisers are available to help. We do not charge fees for initial consultations and you have no obligation to use our services after meeting us. Please get in touch to learn more.