What does diversification of assets mean?

Award-winning journalist Holly Black provides her opinion on diversification of assets

Diversification of assets can help reduce risk

"Diversification is one of the most important words you will ever hear in investment. Very simply, it means spreading your money across different types of investment. 

This includes different types of assets such as shares, bonds and property, and a range of regions such as the UK, US and emerging markets.

Within shares, it means investing across various sectors such as natural resources, technology and financials, and within bonds it means investing in debt of different durations and from companies and government of varying credit ratings.

The reason diversification is so important is that it helps to reduce the risk you are taking on. It is about spreading your money across a range of investments which react differently in various economic environments so that all of your holdings do not rise and fall in tandem. This is known as choosing assets which are uncorrelated to each other; that is, the fortunes of one do not affect the other.

As an example, if you invest in a fund which holds the shares of 100 different companies, it is unlikely that they will all move up and down together – some businesses will thrive while others may struggle and their share prices will move up and down accordingly. If you invest in the shares of a single company and it goes bust, you have lost all your money. But if you invest in 100 companies and a single one goes bust, it will have less of an effect on your portfolio as a whole."

Go global to spread risk

"It’s sensible to invest a number of different global stock markets, because it is less likely that they will all rise and fall as one. The stock market of Japan, for example, has very little to do with that of the UK; if one rises or falls, it does not mean that the other will follow. But achieving true diversification means going a step further again.

Events such as the global financial crisis in 2008 show us that sometimes a number of stock markets do all fall at the same time.

In these instances, holding different types of asset such as bonds, property and gold can help to reduce risk because their fortunes are not necessarily tied to stock markets.

How many funds you hold to achieve diversification will be personal to you and will also depend on the level of risk you are comfortable taking. For example, investing in emerging markets might spread your risk away from developed markets, such as the UK and US, but this can be a racier region in which to invest so may not be appropriate for your risk appetite.

For those who are unsure, an adviser can help you determine which assets will give you an adequate amount of diversification as well as being suited to your investment goals and risk appetite."

Multi-asset funds

"Multi-asset funds are becoming increasingly popular among investors who want a one-stop shop option for their investments.

These typically see a manager invest in a range of assets or in a number of different funds, according to a particular mandate. 

Multi-asset funds offer the ability to invest across a wide range of assets depending on where the manager thinks the best opportunities currently are. Some managers do this by picking their individual investments themselves and others pick a range of funds which specialise in different areas.

Diversification may seem a little complicated but it is a crucial part of investing. Spreading your money across a range of uncorrelated assets helps you manage risk across your investment, which in time will give you a smoother investment journey with fewer dramatic ups and downs along the way."