What exactly is Diversification in Investing?

Diversification is a key part of a wise investment strategy to mitigate risk without necessarily sacrificing returns.

You could think of it as a form of insurance—it doesn't prevent market downturns, but it can soften the blow.

Benefits of diversifying your investments

While diversification cannot totally shield against systemic risks that affect the entire market, such as a global economic crisis or war. By spreading investments across various asset classes, sectors, and geographies, an investor can reduce the impact of any single investment that underperforms.

Diversified portfolios can benefit from the lack of being invested in similar markets. Having different types of investment means even when one market zigs, another can zag, which helps smooth out the overall investment journey.

Although it's not just about reducing the downside, it's also about capturing upside performance. Having a variety of investments allows you to participate in the growth of a wide array of industries and economies, some of which may outperform expectations. 

What you should know about diversification

However, diversification is not a one-size-fits-all solution or a set and forget strategy.

It requires regular rebalancing to maintain the intended risk profile, as market movements can change the original asset allocation.

Over-diversification can also reduce potential returns and lead to complex portfolios that are hard to manage.

So, while diversification is a powerful tool, it must be used with care and be tailored to an individual's investment horizon, risk tolerance, and financial goals.

The diversification settings also require reviewing and updating regularly to ensure the assumptions it was built around are still relevant and reflect any changes to an investor's life stage requirements, investment goals and objectives.

Summary

In simple terms having a diversified investment portfolio means not putting all your eggs in one basket. It's a strategy that accounts for the unpredictability of markets and the limitations of forecasting.

For all investors, it provides a structured approach to managing uncertainty. It results in a more resilient portfolio making it better equipped to weather the storms of market fluctuation.

A well-diversified portfolio is the foundation for long-term financial security, but regular review and adjustment of the portfolio are essential to keep a good diversification strategy that can adapt to changing market conditions and personal financial goals.

At Collinson Wealth Partners we specialise in preparing investment portfolios and plans tailored entirely to the individual client, diversification being a key element of those plans.

The information contained in this publication is general in nature and is not intended to be personalised financial advice. Before making any financial decisions, you should consult a professional financial adviser.