Diversification to reduce investment risk.

The key benefit of diversification is the reduction in the reliance upon one particular stock, asset class, sector or geographical region and hence reducing the overall risk of a portfolio.

A key premise of diversification is that whilst one asset in an investment portfolio may be declining in price, another unrelated asset may be gaining, maintaining balance in the portfolio. There are many different asset classes in which you can choose to invest, each possessing different risk characteristics.

Therefore the best way to diversify your investments is to spread the risk across several different asset types. The principal classes of assets (which could then be divided further within these classes) are usually suggested to be Equities, Bonds (and other fixed interest vehicles), Cash and Property.

Alternatively, Structured Products can provide valuable capital protection features while also giving real equity growth potential. For more information on this please do contact us.

To show how hard it is to pick the right market and the importance of such diversity, the following table shows the best and worst performing markets and asset classes over recent years:

Past performance is not a guide to future performance. 

 Blue = best performing    Red = worst performing         Source: Fidelity Investments May 2005

The aim would be to select asset classes that behave in different ways with little correlation in behaviour to economic influences.

The specific risk associated with a single company stock, can be diverisified by investing in more than one company. There is a clear relationship between the risk to your investment and the number of different shares in a portfolio. By investing in a portfolio of such stock will naturally reduce this stock specific risk.

Equally important, as spreading your investment across different companies, it is also effective to select companies from different sectors. By diversifying across sectors an investor can access stocks with high growth expectations, without overexposing their portfolio as a whole to risk. Holding stocks in a defensive phase should provide the portfolio with some stability should business cycles changes and the stocks in the rapid growth phase drop in value.

Further diversity is often achieved through investing in stocks in differing geographical locations, on the assumption that different geographical sectors may find themselves in different elements of their economic cycle at any particular time. 

Finally, many funds of stocks have particular investment styles. Varying these investment styles can also create portfolio diversity. For example, some stocks are selected as investors believe their value is likely to significantly grow in value over the long term. These are known as 'growth' stock, others may be held and chosen as they are cheaper than the intrinsic worth of the companies in which they represent. These are known as 'value' stock.

We would be happy to discuss your particular investment strategies with you. If you would value this, then please contact us on 01452 311336.