How to master investment portfolio diversification in 2018

Ask any financial expert the secret to investing and portfolio growth and they will answer in one word: diversification.

The value of investments can fall as well as rise, and you may get back less than you invested. Past performance is no guarantee of future results

Why portfolio diversification matters

Portfolio diversification is meant to minimise the risk that you could lose all your money. There is not a single investment option in the world that is entirely risk free – bonds can default, banks can collapse and stock market investments can underperform. By keeping all of your money in just one or two asset classes, you leave yourself vulnerable to any unexpected events. By spreading your money across an array of different asset classes, you can dramatically reduce this risk.

Mastering portfolio diversification is not as simple as investing your money in as many places as possible. Whether you are investing in stocks, shares, bonds, or funds, each transaction incurs a fee. An over-abundance of fees can quickly add up to cancel out any returns that you might otherwise make.

In order to protect your investments from volatility, you first need to create a portfolio diversification strategy. For first time investors, this might seem daunting, but there are a few tricks and tips that can help any type of investor to master portfolio diversification in 2018 and beyond.    

How to diversify your portfolio

1. Invest via funds

Funds offer instant diversification, by spreading your investment across a range of stocks and shares which are all linked by a common theme. If you have an interest in one particular sector or geography, a dedicated investment fund is a great way to introduce your money to new areas without taking on too much risk.

For instance, an emerging markets-themed fund is likely to invest only in countries such as Brazil, India, and Russia, which are classified as having ‘emerging’ economies. Meanwhile, tech-focused funds are likely to invest in companies such as Apple and Tesla.

Recently, there has been a surge in the popularity of multi-asset funds, which invest across a ready-made diverse portfolio on the investor’s behalf. According to a recent count by FTAdviser, there are at least 11,266 multi-asset funds on sale to retail investors in the UK - more than 8000 of which have been launched since 2013. These figures underscore the importance of portfolio diversification for many UK investors, who are prepared to pay steep management fees for the ease of investing in a professionally-handled fund.

Exchange traded funds (ETF) can help to keep costs down by automating the investment process, and cutting out the middleman. ETFs work by tracking certain indices and sectors and mirroring those returns. This allows retail investors to access a variety of different sectors and assets at once, for a nominal fee of less than 1%.

2. Create a balanced portfolio

Traditionally, a ‘balanced’ portfolio refers to a portfolio which is largely split between equities and bonds, with a small amount of money held in cash. Equities are considered a riskier investment option, as their performance is so dependent on the movements of the stock market (although there is the potential for strong gains over time). Bonds, on the other hand, tend to be extremely low risk, and pay out a fixed amount of interest over a certain term.

By combining the high risk, high reward potential of equities with the slow and steady promise of bonds, you can create balance in your portfolio and aim for returns that are a little better than cash or bond yields alone.

Getting the right portfolio balance can take some time. For very conservative investors, a balanced portfolio might include 25% in cash holdings, 55% in bonds, and as little as 20% in equities. A more moderate investor might keep just 10% in cash, with the remaining 90% split evenly between equities and bonds. And an aggressive investor may prefer to place upwards of 80% in equities, 15% in bonds and just 5% in cash.

Regardless of how you choose to split your allocations, by prioritising balance in your portfolio you help ensure a base level of diversification that will protect you from being overly exposed to any one type of investment.

3. Review your portfolio regularly

As your portfolio matures, you will find that your risk appetite or investment goals change significantly. For instance, as you draw closer to retirement, you may prefer to reduce your exposure to the equities market and focus on fixed income investments instead.

Similarly, you might anticipate an upcoming change in your financial circumstances by moving some of your long-term bond investments into a more liquid asset class such as FTSE 100 stocks and shares.

Over time, you may even find that a new asset class emerges that you are keen to invest in. For instance, over the past few years cryptocurrency, peer-to-peer lending and crowdfunding have dominated the alternative investment space, inspiring investors to carve out some room in their portfolios to gain access to these new sectors.

Diversification can take many different forms, so don’t be afraid to switch up your allocations every few years, or even every few months. Set regular review dates, and use this time to sift through your portfolio and ensure that you are still comfortable with the performance of your money, and the amount of risk that you have taken on. And with a little trial and error, you can build your confidence and create a diversified portfolio that delivers increased security and strong returns.

Get your free beginner's guide to investing

●  Discover the benefits of investing your money

●  Learn about the different investment options available and how to get started

●  Understand how to build a diversified portfolio and manage your risk

Form has failed to submit. Please contact IG directly.

  • I’d like to receive information from IG Group companies about trading ideas and their products and services via email.

Get my guide

For more info on how we might use your data, see our privacy notice and access policy and privacy webpage.

Form has failed to submit. Please contact IG directly.

  • I’d like to receive information from IG Group companies about trading ideas and their products and services via email.

Get my guide

For more info on how we might use your data, see our privacy notice and access policy and privacy webpage.

●  Discover the benefits of investing your money

●  Learn about the different investment options available and how to get started

●  Understand how to build a diversified portfolio and manage your risk

Get your free beginner's guide to investing

This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.