One of our most popular articles last year entitled ‘Having a diversified portfolio – Why you shouldn’t put all your eggs in one basket’ discussed why it’s important to diversify and the potential benefits for your portfolio. In this article we want to take it a step further and discuss some of the risks of not diversifying your investment portfolio.
The saying ‘too much of a good thing’ is something to keep in mind when considering what to invest in. You may have heard about a particular equity, bond or fund because it’s perceived as a quality investment that provides strong returns. You have money to invest; you look at how it’s performed and possibly think this would be a good place to invest all your money. The obvious problem here is that if you don’t fully understand your risk tolerance or don’t have a proper strategy in place for how you want to grow your wealth, then you could be taking one of the biggest investment risks of all – potentially losing everything.
Diversifying investments basically means having a good mix of equities, bonds, cash and funds within your portfolio all working together to deliver the potential for a more balanced return in line with your risk tolerance.
So what exactly are the risks?
- If you put all of your money into an investment that consists only of shares issued by a single company and that company’s shares suffer a serious downturn, your portfolio will sustain the full brunt of the decline.
- By investing all of your money in one asset class, you may not get the benefit of riding out market volatility as your investment will either, if you’re lucky, sharply go up or if you are not so lucky severely go down, rather than an overall balance of both.
- If you have invested all of your money in a bond and the company goes bust or interest rates decline, again your portfolio will bear the full brunt of it and you could lose all of your initial capital.
- With no investment strategy in place you might start chasing performance through higher-risk investments. However, if this doesn’t match your risk tolerance and the investment performs badly, your losses could be significant.
- In a market downturn, you may be tempted to flock to lower-risk investments – again, without a proper strategy in place this can lead to missed opportunities when the market recovers.
Ultimately, how you build your wealth and mitigate the risks with investing will depend on how much money you have to invest, your investment strategy and your tolerance for losses.
John Sweeney, an executive vice president at Fidelity Investments, commented that “being disciplined as an investor isn’t always easy, but over time it has demonstrated the ability to generate wealth, while market timing has proven to be a costly exercise for many investors. Having a plan that includes an appropriate investment mix and regular rebalancing can help investors overcome this challenge.”
Whilst diversification does not necessarily remove all the risks of investing, it has been proven to mitigate them. So, if you are serious about creating long-term wealth, taking advice and ensuring that you have the right mix of asset classes within your portfolio should help you to create the level of growth and income you need to achieve that goal.
The purpose of this article is to provide technical and generic guidance and should not be interpreted as a personal recommendation or advice.
These links may be useful: www.moneyadviceservice.org.uk and www.direct.gov.uk
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