2 Minute guide to diversification and its potential benefits

If you are new to investing, diversification may be a new term for you. We take a quick look at this important element of investment

People can often be put off investing in financial markets for fear of losing money. Who can blame them? The press is full of horror stories of people losing their life savings because of market crashes or failing companies.

Bad news sells better than good news (we all have a slightly macabre interest in the misfortune of others).

Of course, people can lose money from investing. If you don’t want to take a risk there’s always the trusty savings account. They provide a return, albeit a meagre one because interest rates are low, and your money should be safe.

However, in the current climate, inflation will likely eat away at the value of your savings. Investing does come with risk, but it also offers the potential of higher returns than leaving money in a savings account.

The benefits of diversification

Experienced investors will generally take steps to mitigate risks. One of the most basic ways to do this is called diversification, which basically means spreading your money around in different asset types.

Although stocks fell sharply in value in 2008, government bonds rose. Diversification doesn’t guarantee you won’t lose money but it should help smooth the highs and lows and help lessen any emotional roller coaster ride.

It also helps you retain access to the money you need: in times of stress, the ease in which you can buy and sell an asset is critical. This varies between assets, known as the asset’s liquidity. For instance, property can be more illiquid than equities. Diversification can help.

Too much diversification?

Don’t go mad though. Investing in too many different assets and asset classes can leave you swimming in confusion.

There is no fixed rule as to how many assets and asset classes a diversified portfolio should hold: too few can add risk, but so can holding too many. Hundreds of holdings across many different asset classes can be hard to manage, and diversification for the sake of it runs the risk of poorer performance, sometimes called “diworsification”.

Schroders’ portfolios on OpenInvest are diversified portfolios, invested across a range of asset classes designed to achieve your chosen investment goal.

If you are unsure as to the suitability of your investment, you should speak to a financial adviser. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.

Great article!!!

Great point re having too much diversification. Just goes to show the importance of professional management in achieving properly diversified portfolios.

Interesting to hear that its possible to over diversify

Thank you, very informative