Diversification has long been considered one of the key principles of successful investing, helping investors avoid overexposing their wealth to any particular sector or asset class that could increase their risk.
Over time, many have come to see diversification as simply investing in many different asset classes, forgetting that some may be unsuitable for them. As such, diversifying poorly might mean that you hinder your wealth’s potential for long-term growth.
Read on to discover how a more nuanced approach to diversification could help you to mitigate risk and give your money more opportunities to generate positive returns.
Diversification has come to be defined as needing to include a wide range of asset classes in your portfolio
Most investors believe that owning shares in a wide range of asset classes is a suitable way to diversify their portfolio and reduce the risk that their wealth is exposed to. Alongside equities, bonds, and cash, a portfolio might also include:
- Precious metals
- Real estate schemes
- Infrastructure projects
- Venture capital.
Some portfolios may also incorporate other more unusual types of investments.
While these can play a role in an investment portfolio, it’s important to choose them for the right reasons. Diversification alone might not be enough to justify including certain investments in your portfolio.
Randomly investing in different types of asset classes in this way, purely to add variety, could do the opposite of what you intended. Indeed, it may even hinder your ability to achieve your long-term financial goals.
Diversification is more nuanced than most investors realise
Perhaps, rather than simply viewing diversification as “not putting all your eggs in one basket”, a more helpful definition may be “owning a wide variety of investments with different characteristics”.
Implementing this more technical definition would require you to begin by researching which asset classes are most likely to offer your portfolio the potential to achieve your long-term goals. Then, diversify the investments you make within these asset classes to mitigate risk and support your wealth accumulation.
Letting your personal goals guide the asset classes that are included in your investment portfolio is more likely to offer the desired outcome over the long term.
Experience tells us that being more strategic with the asset classes you choose and ensuring they are aligned with your goals, circumstances, and attitude to risk will usually deliver better results than attempting to diversify using asset classes that do not boost your chances of achieving your goals.
When you build a portfolio using the most suitable asset classes for you, you unlock greater potential for market gains
Diversification is an important part of investing for your future, but it is more nuanced than many investors realise. So, it’s important to spend time truly understanding what it means for you so that you can take advantage of this key principle of investing.
As the famous investing guru Jack Bogle once said: “Don’t look for the needle in the haystack – just buy the haystack!”.
By reviewing your portfolio on a regular basis – ideally annually as a minimum – you can keep track of the balance of your investments, making sure they are diversified in line with your own goals and circumstances. In doing so, you can feel confident that you are making the most sensible decisions for your wealth both today and in the future.
