Investment diversification

What is investment diversification and why is it so important?

 

1. What is investment diversification?

2. What is an asset class?

3. Why diversify your investments?

 
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What is investment diversification?

Investment diversification involves creating a portfolio with a wide range of investments across a variety of different asset classes. 

Diversifying your investment portfolio is one of the best ways to minimise volatility and reduce risk, and it’s important that, when deciding where to invest, you don’t put all your eggs in one basket. 

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What is an asset class?


An asset class is a group of investments/securities that share characteristics and behave in a similar way in the marketplace.

There are four main asset classes;

  • Cash
  • Fixed interest investments
  • Property
  • Shares
Cash

Cash is the safest asset class as it doesn’t pose a capital risk and is - if in the form of a bank account or Cash ISA - protected by the government through the FSCS for up to £85,000. 

However, although it is generally very safe, cash is susceptible to inflation risk and provides limited opportunity for growth. 

Fixed interest investments

Fixed interest investments - including bonds - involve investors loaning their money to businesses or governments in exchange for a security that pays an agreed interest rate. 

The biggest advantage of fixed term investments is that you know exactly how much you’re going to earn. They’re also less risky than other asset classes, such as shares, and they have the potential to provide regular income. 

Disadvantages of fixed interest investments include the possibility of issuer default and their susceptibility to interest rate risks.

Property

Investing in property can include buying your own home, or investing in buy-to-let. 

Although investing in property has a medium risk profile and requires long-term investment, it also has a good track record of beating inflation and, if you buy-to-let, it can provide a great extra stream of income. 

Shares

Buying shares involves buying a unit of ownership in a company. 

While the risk profile of investing in shares is medium to high, it also has the potential for higher returns.

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Why diversify your investments?

Diversification is the key to investment success. 

By spreading your money over a variety of investments, you’re ensuring that, if one of them was to experience a downturn, your whole portfolio will not suffer. 

Often, falls in the value of one asset will be compensated by rises in another.