Diversification: A Proven Strategy for Uncertain Times
How can you prepare your savings and investments to weather the ups and downs of the market, and be ready to take advantage of opportunities as they arise?
Financial advisers and economic analysts will uniformly provide the same advice: stay the course in the face of short term volatility – and diversify.
What is diversification and why is it important?
Diversification is a key component in any wealth management strategy. An investment portfolio which is diversified contains a mix of distinct asset types and investment vehicles. The strategy is founded on the rationale that a portfolio constructed of different kinds of assets will, on average, yield higher long-term returns while lowering the risk of any individual holding or security.
Diversification strives to even out the portfolio in the face of unsystematic risks, so that well-performing investments balance out those that are performing negatively.
Why diversifying is right for everyone
History can provide plenty of examples that show the old adage about eggs and baskets is true – spreading risk has always made sense.
First came the South Sea Bubble, which eviscerated the fortunes of many an 18th century British investor and led to riots in the streets of London. For two examples from the past century however, we can look to Australian nickel mining company, Poseidon, and fashion house Polly Peck…
Fifty years ago, the share price of Poseidon rocketed from A$0.80 to $280.00 over the course of a few months before profit-taking began and the share price crashed. Receivership followed in 1974.
Twenty years later, another ‘rising star’ of the stock market burned out. Minor fashion house, Polly Peck, was acquired by new owners in 1980 and used as a vehicle for ventures in Northern Cyprus. After a series of deals in the 1980s, the growth was such that the company’s shares entered the FTSE 100, before being suspended in September 1990 amid fraud allegations.
These examples provide a clear warning to today’s investors about the risk of blindly following the herd, and misplacing your trust in an opportunity ‘not to be missed.’
A sensible way to achieve a spread of risk is through collective investment schemes.
Financial Options Group founder and CEO Christian J Pepper comments: “Over the past 20 years, no single asset class has managed to outperform the others all of the time. This is something you can examine yourself by looking over a ‘heat map’ of asset classes, and a chart like this will reveal that while cash is the lowest performing type of asset class across the board, there is no overriding asset class which comes out on top.
“For this reason, mixing and matching different types of investment is an established strategy of wealth management. Through asset allocation, your investments are divided across equities, bonds and alternative investments into different groupings in order to balance risk. While the specific outcome depends on the length of your investment, ie the time horizon, and your attitude to risk, through diversification it is possible to maximise returns while making your investments more resilient to market volatility.”
Diversification for preserving wealth
You’ve worked hard to save and invest throughout your working life, and it’s crucial that you have sufficient assets to realise your goals during your lifetime and to create an enduring legacy for your family. For these reasons, your wealth management strategy must be designed around the preservation of your wealth, helping against the erosion of wealth over time.
Certain things will be under your direct control, such as your spending habits, but when an unexpected event, such as stock market volatility, takes place, having a diversified portfolio, together with a holistic view of your finances, can help to protect your investments.
As a general principle, any investment in shares needs to be spread across different areas, such as industry sectors and geographical regions, so that if one share price slumps it only affects part of your overall portfolio. A sensible way to achieve a spread of risk is through collective investment schemes with a risk profile to match your objectives and needs. Our expert team can advise on the investment strategies and products most appropriate for your individual circumstances.
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