In financial terms not putting all your eggs in one basket is a jargon free way of saying it is important to consider having a diversified portfolio, the extent of diversification and the mix of investments in it, will depend on your financial goals. In this article we explain a little bit more about the types of investments that could make up a diversified portfolio. Your portfolio needs to reflect your personal financial goals and even those can change over time.
“Investing money is the process of committing resources in a strategic way to accomplish a specific objective.” ― Alan Gotthardt, The Eternity Portfolio
So what does a diversified portfolio mean?
Generally speaking, the purpose of diversifying your investments into different asset types is to help minimise risk by balancing out any fluctuations in the market value. For example, if you have only invested in one company share and the price of that company share falls, your whole investment would suffer the full cost of that decline. However, if you had invested your portfolio in at least two different assets and the other one was performing well, you would have reduced the risk of loss on the total capital you had invested.
Before embarking on whether or not a diversified portfolio strategy is the right step for you, it’s important to understand your investment risk profile (which can range from very low, low and medium to medium/high, high and very high), as well as your goals and objectives.
Assessing risk is something we undertake with our clients at the beginning of their journey with us. Getting to know them, their aspirations and what they want to achieve allows us to help ensure that we are working with them to select the right types of asset classes. Regular reviews also ensure that they are performing as expected and allow us to make changes where necessary to keep them on track. It is also an opportunity to check if personal circumstances have changed and how that might impact on financial requirements if you have signed up for an ongoing service.
What makes a well-diversified portfolio?
As discussed previously, this depends on your risk, but if possible, including a mix of shares, bonds, mutual funds and cash will help to ensure your investments are well-diversified. So let’s look at each asset and the reasons for having them in your portfolio.
Shares and Bonds
These are two of the main classes of assets investors use in their portfolios. Shares are investments that give you an ownership stake in a company and bonds are loans made to a company which are called a corporate bonds or to other organisations like the government which are called gilts. Shares are generally considered a higher risk and more volatile investment than bonds, but there are many different kinds of shares and bonds, which give you a varied level of volatility, risk and return on your capital.
For example, when creating a portfolio that contains both of these assets we may recommend a mix of 80% shares and 20% bonds for an aggressive investor whilst for the more conservative investor we may recommend a 20% shares to 80% bonds mix.
These are professionally managed investment portfolios in themselves because they are made up of a variety of funds such as shares, bonds, money market instruments (cash investments) and similar assets. Mutual funds are operated by money managers, who invest the capital of several different investors in order to produce capital gains and income for them. Mutual funds are structured and maintained to match a particular investment objective and are designed to achieve a particular rate of return on your investment in return for accepting a certain level of risk.
If you have limited capital to invest and would prefer a more simplified investment portfolio, we may recommend a balanced mutual fund in which to invest. These types of investment may be more suitable for short to medium term objectives as opposed to longer term goals such as saving for your retirement income. If you are looking to minimise capital gains tax or generate a reliable income stream and you are investing large amounts of capital, these more complex needs may require a different type of strategy.
Whilst this is generally the less risky element of diversifying your portfolio, the benefit of including cash and other short term money market assets is that it provides you with access to your capital in the event of an emergency or; if you are looking to liquidate an investment quickly to take advantage of another investment opportunity. However you should be aware that this may result in a lower return on your investment.
What issues should you be aware of with a diversified portfolio?
The availability of choice that comes with diversifying your portfolio may be an advantage as long as it is managed properly. Being too diversified can also have a negative impact and could minimise the objectives you are looking to achieve, so it is important to take advice so that we can help ensure that you are only invested in the assets that suit your risk profile as well as your short, medium and long term goals.
Is this the right strategy for you?
Returning to our headline statement of not keeping all your eggs in one basket, another statement that rings true is that no two investors are the same. There is no generic diversification strategy that will necessarily meet the needs of every investor. Your risk tolerance, investment objectives, how much capital you have to invest and to a certain extent the level of investment experience you have will play an important part in deciding what types of investment are right for your goals.
At Bridge we understand that the choices you have may make you feel overwhelmed which is why we are here to explore and find you the right solution for your needs.
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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