The Importance of Diversification and Asset Allocation When Investing
Many people ask why diversification and asset allocation are important when investing. So in this post we’ll look at what they actually mean.
Diversification and asset allocation are closely linked, but there is also a subtle difference.
Diversification could well be the origin of the old saying ‘don’t put all your eggs in one basket’. It means spreading your money across a number of different investments.
Diversification is a time-honoured way of spreading the risk. If one investment underperforms then the chances are the others won’t. (And, if you’ve diversified well, they may even over perform!)
A simple example is if, for example, you want to invest in stocks and shares then you would diversify your portfolio by investing in a number of different companies.
Asset allocation takes this a step further. It means dividing your investment up between different asset classes which have different characteristics. For example, by putting some of your money in cash, some in bonds and some in stocks and shares or funds. And then within that, across different types of stocks and shares, funds or bonds each with different characteristics.
So, for example, you might opt for some investments that are long term and others that are short term, some that are seen as safe while others more risky, and some that offer income while others have good prospects for growth. If you invest in stocks and shares, for example, you might invest across a range of companies including small, medium and large cap companies.
It’s probably true to say that a fully balanced investment portfolio depends on both diversification and correct asset allocation. They both help you get the risk-return balance just right for you.
So, how do you diversify your investments and allocate assets correctly?
First a word of warning! It is possible to over-diversify your portfolio. Putting money into too many investments that are too similar could actually reduce your returns.
This is sometimes known as diworsification!
As a first step you need to consider three important points: What your investment goals are. What your appetite for risk is. And finally, what your investment timescale is. For example, are you investing for five years, ten years or perhaps for retirement?
Once you know that you can begin to create a properly diversified and balanced investment portfolio.
Diversification and correct asset allocation might sound complicated but it’s something that W1 Investment Group are highly experienced at advising on. If you would like to find out more about the investment management service that we can provide – or just find out more about W1 Investment Group – please get in touch.