Why diversification is worth the risk

The phrase “don’t put all your eggs into one basket” comes to mind when I think about diversification in an investment portfolio. Diversification is really just another way of helping to reduce your investment risk – committing to longer-term investments is another (more on this later). But some of the decisions you have to make in order to create a diversified portfolio can sometimes feel rather counterintuitive, which can leave people feeling unsure about this route.

Going against what seems counterintuitive

Here at SK Financial, our portfolios cover a range of asset classes and each asset class behaves differently – equities are, for example, typically more volatile than bonds. With this in mind, it would seem sensible to assume that if you wanted to reduce your risk, you would have a portfolio made up purely of bonds. However, it would actually reduce your risk if you were to introduce a small investment in a higher risk equity fund invested in a completely different area. The reason being that the equity fund will react differently to the bonds when it comes to varying economic events, so you are essentially covering all bases. As such, an effective combination of different asset classes can significantly reduce the risk of a portfolio without reducing its potential for growth. Ultimately, there are always pleasant and unpleasant surprises within asset classes and being diversified can help to balance out these surprises and ultimately reduce losses.

And while there are of course a few downsides to diversifying – it can limit your gains for example and trading fees often need to be applied – if you’re disciplined, having your eggs in lots of different baskets is absolutely the best way to go.

In it for the long haul

But as I mentioned in the introduction, committing to longer-term investments will also help mitigate any potential investment risk. We monitor the behaviour of the different asset classes closely and yes, many are losing money this year, but we have seen that they tend to grow in value over time. Corrections, such as what is happening now, are normal and healthy for the long-term progress of the markets.

No one can predict what the markets are going to do, but history suggests that rather than trying to time the market, it is better to focus on building diversified portfolios for the longer- term because markets tend to rise over time – even if there may be short-term fluctuations – and even some losses – along the way.

A guard against inflation

We understand that when the markets start to fluctuate, people get twitchy about their investments and may consider focusing on cash, seeing it as a safer form of saving. However, with inflation now hitting higher levels than we have seen in decades and interest rates still below the rate of inflation, this money will simply devalue over time. So again, whilst it feels like you need to act, having the courage of your convictions and investing in a longer-term diversified portfolio will result in far better, more profitable results.