Investment Diversification – The Benefits
Investment Diversification can be described as when an investor chooses to invest in a number of asset classes. Investment Diversification enables an investor to spread or reduce risk in the long-term. By having this level of diversification within a portfolio, an investor can have ‘peace of mind.’ For example, if something is happening in one market, and the portfolio is diversified, you might be impacted to some extent, but there are many other asset classes that may not have the same market reaction. So generally speaking, the standard asset classes are equities, fixed income, property, alternatives, and cash.
Within the equity markets, there are different geographic regions: the UK, Europe, the US, Asia, and emerging markets. Emerging markets have a different dynamic when compared to domestic or international equities. They are a developing country, where investments are riskier but are often accompanied by higher returns. So maintaining some sort of geographic diversification must be considered when investing, and it’s important to ensure that risk is spread.
For example, a holding in emerging markets may see a good long-term performance but it will be accompanied by high levels of market volatility. In this sense ‘volatility’ is the up-and-down movement of the market and it is often perceived as a measure of risk. Whereas an investment in the UK or the US may see lower long-term growth, but with a reduced fluctuation in prices.
Risk can also be spread by holding investments across a range of sectors, so companies in different industries will be subject to different performance drivers and economic cycles. For instance, technology companies will not have the same return profile as global mining companies, nor will banks or insurers perform in line with pharmaceutical and healthcare firms. Overall, diversifying your portfolio can help your investment strategy. By having a diversified portfolio you have the potential to create a scenario which means you can take less risk for the expected return.
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