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Why diversification is the holy grail for investors

26 April 2019

3 minute read

‘Diversification’ is the mantra of the investing world but to what end is diversification the means? And, can we tell what kind of diversification is actually worthwhile?

Who's it for? Confident investors

What you’ll learn:

  • The importance of diversification
  • Why diversification matters
  • How to benefit from diversification

‘Diversification’ is the mantra of the investing world. Yet it’s nobody’s ultimate goal; no-one is thrilled by the mere prospect of a technicolour portfolio. What investors are striving for are good returns on their money.

So, to what end is diversification the means? And, can we tell what kind of diversification is actually worthwhile?

Noise-cancelling

The classical argument for a diversified portfolio is that it enjoys reduced volatility because when one of your investments isn’t performing so well, another will hopefully be performing strongly.

More precisely, what’s going on is that by spreading your money across a range of investments, giving you exposure to different geographical regions, and asset types, such as shares and bonds, the overall risk of the portfolio will be diluted. For example, if you only invested in Volkswagen (VW) shares, you would be exposed not only to the economic drivers affecting the car industry, but also the particular actions of certain individuals at that company. But if you held shares in other companies as well, or invested in a fund, the returns on your investment wouldn’t be dependent on the performance of VW alone. In this sense, diversification enables us to reduce unnecessary risk.

However, this reduction in risk is somewhat abstract – most people don’t notice or care about the variability of their portfolio’s returns stretching back over the past few summers – they’re simply interested in whether it’s worth more now than when they originally invested.

Cliché for a reason

Instead, the more tangible benefit of diversification lies in that old adage of not putting all your eggs into one basket. Clearly, if you only invest in the shares of a single company, there is a risk that your investment could be completely wiped out – think Carillion. However, there’s also a chance that you could invest in a company whose shares soar in value. It’s quite a gamble though. By diversifying, you won’t get either extreme at the ends of the spectrum – the performance will always be somewhere in the middle of the rankings.

If you then look across a number of periods – be it days, months or years – you’ll inevitably find that every asset class has, at some point, been the short straw and performed poorly. But a blend will never hit the bottom.

It’s important to note that we are talking about relative performance across different investments, not absolute returns. Diversification can’t protect against losing money. The key benefit of spreading your eggs is sleeping peacefully knowing that, whatever happens, you’ll never wake up to being in last place.

Investment conclusion

Diversification is just one of the qualities sought from portfolios, but it’s not an end in itself – what you really want is enhanced robustness.

On top of that, your aggregated investments must strike the right balance between risk and expected return. This is a challenging problem to solve.

Investing in a fund, rather than buying shares is a great way of achieving this and getting immediate diversification as the fund you choose will invest in multiple companies.

Ways to invest

A global fund can be a good place to start as it will invest in companies and industries from markets all over the world. If you’d prefer to stick to developed markets, you may want to consider the Barclays GlobalAccess Global Equity Income Fund Acc. Each GlobalAccess fund is expertly managed by Barclays, who appoints and carefully blends one or more investment managers to invest a portion of the fund’s assets with the aim of outperformance. Many of these leading managers are unavailable to retail investors in the UK other than through Barclays.

Alternatively, the Barclays Funds List could help you to narrow down the wide range available to invest in. These funds are selected by Barclays investment specialists and, based on our research, they’re the funds that we believe have the potential to generate consistent returns over the medium to long term. Examples of funds invested in developed markets equities on the Barclays Funds list include the Janus Henderson Global Equity Income Fund Acc, and the Jupiter Ecology Fund Acc.

However, while a fund gives greater diversification than buying shares in one or two companies, you can dilute the overall risk further by investing in a number of funds which have different types of underlying holdings. For example, as well as developed markets, you may want exposure to some of the world’s emerging economies, or specific sectors such as technology. It’s also worth considering other asset types such as bonds and commercial property to add further diversification.

If building a diversified portfolio sounds like a daunting task, there are simple solutions available. Multi-asset funds invest across a range of asset classes and regions, offering a globally diversified one-stop solution for investors. One example is our Barclays Ready-made Investments, which allow you to choose the level of risk you are comfortable with.

You should only be thinking about holding these investments for at least five years as they’re designed for the long term.

All of these investments can fall in value as well rise; you may get back less than you invest.

These are our current opinions but the future, as ever, is uncertain and outcomes may differ.

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The value of investments can fall as well as rise. You may get back less than you invest. Tax rules can change and their effects on you will depend on your individual circumstances. Smart Investor doesn’t offer personal financial advice. If you’re not sure about investing, seek independent advice.

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