When we give clients investment advice, we always recommend that they have a diversified portfolio of assets. In this weeks article, we are going to look at what diversification is.

What is diversification?

Diversification is a method of reducing the risk that your money is exposed to. This is done by investing in a selection of different assets.

How does diversification work?

Say you buy shares in BMW. They make luxury cars, so when the economy is doing well, people buy more BMW’s and the share price goes up. If the economy isn’t doing well, people won’t be buying luxury goods and the share price falls. People will still be buying nappies and washing detergent though. So buying shares in Procter & Gamble will counteract against the fall in the BMW share value. Diversification is splitting your investment between BMW and Proctor & Gamble to reduce the overall risk that your money is exposed to.

You don’t just limit your diversification to two stocks. You buy hundreds or thousands of different stocks. As well as different sectors performing at different levels, so will different regions too (look at the China now). We don’t have a crystal ball, so we can’t tell you which ones will perform well or when it will happen. That’s why we invest in different regions and different sectors.

Bonds and stocks tends to move in opposite directions (although for the last few years they have been going the same way together). Adding bonds to your portfolio, you will have some assets that should be going up in value when the stock’s value is falling and vice versa.

Diversification through funds

Buying hundreds of different stocks and bonds by yourself can be expensive. There are lots of different funds and ETFs available that allow you to access ready made access to diversification. For example one of the fund managers I use has 11,000 different stocks in their portfolio! You could never get that level of diversification by yourself.

Do you know if your pension or investments are diversified? What different assets classes are they invested in?

If you have any questions, please contact me directly at steven@bluewaterfp.ie