Please refer to the glossary for an explanation of the investment terms used throughout this article.
It is possible that your long-term financial well-being relies too much on too few investments.
There are often good reasons why you could be over-exposed to certain assets. You might, for instance, have acquired company shares through your employer’s share scheme, or perhaps inherited a rental property.
Of course, a handful of well-chosen assets should perform better than a broad collection of poor quality or overvalued ones. However, how can you be sure an investment will realise its potential or not be derailed by an unforeseeable event or trend?
The more narrowly you invest, the more reliant you will be on individual assets, or parts of the global market, to deliver the returns needed to realise your financial goals.
While it can never guarantee against losses, spreading your money across different types of assets can help protect your portfolio from individual failures and, to some extent, wider shocks in the market. Owning a breadth of assets can also expand the potential upsides of investing, by widening your pool of potentially successful investments.
Different asset classes have historically tended to perform differently in the same circumstances. Past performance should not be seen as a guide to future performance, but company shares have often performed well when bond markets have suffered, and vice versa, as illustrated in the chart below.
‘Global shares’ illustrated by the MSCI AC World Index
‘Global bonds’ illustrated by the Bank of America Merrill Lynch Global Broad Markets Index
Source: Morningstar, Datastream, Bloomberg, 31 December 2016. Please note that all returns are in UK pounds
Past performance is not a guide to future performance
Investors who held a combination of bonds and equities would have generally seen the value of their investments fluctuate up and down less erratically, over this period, than if they owned just one or the other.
You can invest in many other types of assets to further balance your portfolio, such as commercial property, but you can also add breadth within asset classes. For example, corporate bonds generally offer higher possible returns than mainstream government bonds, although the risk of defaults – or repayments not being met – is generally seen as greater.
Another option to diversify your portfolio is to reduce local and currency risks by owning assets across regions and valued in different currencies – rather than just UK-based investments denominated in UK pounds, say.
Constructing a diversified portfolio is not always easy. It might require resources and expertise that you, as an individual investor, might not have. For this reason, there are professionally managed funds that pool many individuals’ money to invest in a greater breadth of assets.
Many funds will focus on just one narrow part of the market, while others have more flexibility to invest across the spectrum of assets. So-called multi-asset funds combine a mix of different assets in one single, diversified investment.
These ‘all-in-one’ funds are not one and the same, however. Each actively managed multi-asset fund has its own objective and approach to risk and return, with its own blend of assets ‘under the bonnet’ to try and achieve this. Like any investment, you should check that the strategy and assets within any fund are right for you.
Whether you are in the early stages of building up your investment pot or drawing on them in retirement, it is always wise to check that your future financial well-being does not rely on how any one asset class performs.
Diversifying your portfolio effectively could help protect your hard-earned investments from any nasty shocks and cast your net wider in the hunt for potential returns.
Important information
The views expressed in this document should not be taken as a recommendation, advice or forecast. We are unable to give financial advice. If you are unsure about the suitability of your investment, speak to your financial adviser.
The value of investments and the income from them will fluctuate. This will cause the fund price to fall as well as rise. There is no guarantee the fund objective will be achieved and you may not get back the original amount you invested.