Wealth Building
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Harvey Jones
19.07.2019

Diversification is an investor’s best friend

Would you pour every single cent or penny you have into Bitcoin right now? Or an offshore oil and gas explorer, a high-risk biotechnology start-up or hotly tipped frontier market?

Of course you wouldn’t. Only a complete novice would do such a thing, or maybe a high-stakes gambler. Spreading your money across different investments to reduce the damage if one of them crashes is called portfolio diversification, and every investor does it to a greater or lesser degree. A properly diversified portfolio brings two massive benefits, reducing risk and making you richer. It's basic common sense, really, and there's an old, old saying that sums it up: never put all your eggs in one basket. Or rather, all your nest egg. The tricky part is getting the balance right.

Keep your shirt

Diversification is vital when investing in stocks and shares, because you don’t want to gamble your entire pot on the next Enron, Kodak or Lehmans. A properly diversified portfolio of direct equities should therefore include at least 15 or 20 companies, to spread the risk. Don't just buy any company that takes your fancy, though. They should operate in different sectors, such as energy, financials, technology, mining, media, insurance, industrials and so on, to give you exposure to different parts of the economy. If you owned banking stocks Barclays, Lloyds and Royal Bank of Scotland before the financial crisis, you didn’t really have any diversification at all. Of course the simplest way of doing this is to buy an investment fund giving you a balanced spread of equities.

Global balance

Most expat investors instinctively lean towards their home stock market, but you need global diversification as well. Different countries and regions tend to perform at different times – emerging markets started the Millennium with a bang, while US stocks have flown over the past decade. You then need to balance these regions with the UK, Europe, Asia-Pacific and Japan, and possibly a sprinkling of frontier markets as well. You can further diversify by investing in one or two commercial property funds, and possibly commodities as well. Remember to review your portfolio regularly to avoid becoming overweight in one particular sector. Right now, many investors may have outsize exposure to the resurgent US, and should consider reallocating some profits elsewhere.

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Look beyond stocks

Most of your portfolio should be in stocks and shares, because they should deliver the highest returns over the longer run. However, you need to balance this by investing in less risky asset classes, such as bonds, cash and gold. These are known as "non-correlated assets”, because they perform differently to equities at different stages of the economic cycle. The gold price tends to rise when investors get nervous, offsetting your losses from falling share prices. However, gold can be volatile too, and doesn't pay any interest, so I limit it to 5% or 10% of your portfolio. As you get older, you could sensibly have around a third of your portfolio in government and corporate bonds, which offer fixed income and some capital growth, and with less volatility in stocks and shares. Ultimately, your portfolio mix will depend on personal factors such as age and attitude to risk, which change over time. Diversification is a moveable feast.

Word of warning

One potential downside of diversification is that your portfolio ends up going nowhere fast, as your losses from one asset class offset your gains elsewhere. So don't overdo it. Stocks and shares are the ultimate wealth driver and should form the bulk of your portfolio. Cash, gold and bonds are there to take a little risk off the table, but you cannot eliminate risk altogether, and you shouldn’t try. Ultimately, your best friend is time. Over the decades, every sector has its day in the sun. Diversification will let you enjoy it.

Time to track

Diversification can be simpler than it looks. Low-cost exchange traded funds (ETFs) are perhaps the best way to get exposure to a spread of different asset classes. So for example if you want exposure to the US, you could get a balanced spread of shares by purchasing the SPDR S&P 500 UCITS ETF (SPX5). Similarly the iShares Core FTSE 100 ETF (ISF) gives you a mix of top UK companies, which you could supplement with the Vanguard FTSE Europe ETF (VGK). You can buy the iShares MSCI Emerging Markets ETF (EEM), or even country-specific funds such as iShares MSCI Russia ETF (ERUS) or HSBC MSCI China UCITS ETF (HMCH). Or you could really simplify matters by simply buying a one-stop globally diversified fund such as the Vanguard FTSE All-World UCITS ETF (VWRD), which tracks the performance of thousands of large and mid-cap companies in developed and emerging countries.

Specialise

For exposure to property, options include Vanguard Real Estate ETF (VNQ), while the iShares Global Govt Bond UCITS ETF (IGLO) gives you a spread of government bonds around the world. There is a huge range of commodity ETFs investing in everything from crude oil to natural gas, sugar, copper and cocoa beans. Many ETFs track gold including ETFS Physical Gold (PHAU) and iShares Physical Gold (SGLN). Another alternative is to take out one of the Vanguard LifeStrategy ETFs, which aim to do the job of diversification for you. For example, you could choose a fund with 80% exposure to equities, and 20% in bonds. Or 60% in stocks, 40% in bonds, and so on.

Do it now

The global bull market has been running for more than a decade now, and has to hit the wall at some point. A properly diversified portfolio should protect you from the worst, and the best time to prepare yourself is today.

 

Harvey Jones has been a UK financial journalist for more than 30 years, writing regularly for a host of UK titles including The Times, Sunday Times, The Independent and Financial Times. He is currently the personal finance editor of the Daily Express and Sunday Express, and writes regularly for The Observer and Guardian Unlimited, Motley Fool and Reader’s Digest.


Internaxx Bank S.A. accepts no responsibility for the content of this report and makes no warranty as to its accuracy of completeness. This report is not intended to be financial advice, or a recommendation for any investment or investment strategy. The information is prepared for general information only, and as such, the specific needs, investment objectives or financial situation of any particular user have not been taken into consideration. Opinions expressed are those of the author, not Internaxx Bank and Internaxx Bank accepts no liability for any loss caused by the use of this information. This report contains information produced by a third party that has been remunerated by Internaxx Bank.

Please note the value of investments can go down as well as up, and you may not get back all the money that you invest. Past performance is no guarantee of future results.

 

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