For most investors, diversification makes sense as part of the asset allocation process and as a way to help manage risk.
It can also make sense in times of uncertainty and volatility. Last week for example, the FTSE 100 saw its biggest weekly loss since early November 2016, falling 213.04 points, or 2.91%, to 7,114.55. However, after the Macron vote, this week has seen stocks worldwide reach record highs, with the MSCI All-Country World Index, a gauge of global stocks exceeding its previous lifetime high set last month and France’s CAC 40 surging to its highest level in more than nine years. The German DAX also set a new record high, the Euro Stoxx 600 reached a 20-month peak and the Nasdaq has broken through the 6,000 mark for the first time.
There is possibly more volatility and uncertainty ahead however, with the second French vote, the UK election and of course the Brexit negotiations for starters.
Investors tend to check their investment portfolios at times like these – when the stockmarkets are falling or when stocks are soaring. However, both situations tend to cloud the judgment of even the most battle hardened investors and can lead to rash investment decisions being made.
It is much better to keep calm – and to review your portfolio and asset allocation, not just when things are flying or in freefall, but on a regular planned basis. This should be at least once a year, or when there is a significant change to your financial circumstances. Such a review is a good time to look at rebalancing your portfolio as well as evaluating your specific investments.
Setting and maintaining your strategic asset allocation is one of the most important factors in your long-term investment success.
The role of diversification in this process is not about boosting performance so much as helping to manage risk. By agreeing the level of risk that you can live with, based on your goals, time horizon and tolerance for market volatility, a diversified portfolio created specifically for you has the best chance of achieving your aims. The asset allocation you decide upon should match your own objectives and attitude to risk and diversification can help the process of seeking optimum returns for that level of risk.
The benefit of diversification is because historically different assets behave differently. This is called correlation. Over the long term, evidence shows that cash tends to have a very low correlation with equities and property; that property has a higher correlation with equities; and that equities have low correlation with fixed interest.
You should also look to stay diversified within each type of investment. In terms of stocks, for example, this could mean diversifying across equities or funds by market capitalisation (small, mid, and large caps), sectors. You should also consider both industry as well as geographical sectors – in other words not just the UK but also the US, Europe, Japan and emerging markets for example, as not all regions do well at the same time, or to the same degree. You may want to consider a mix of styles, too, such as growth and value.
To summarise, the aim of diversification is to help reduce risk, so that your investments as a whole have the best chance of achieving your aims. Your actual asset mix needs to match your own personal goals, objectives and attitude to risk, which means the right portfolio for one investor is not likely to be appropriate for another.
The title started this article off with a nod to Bobby Darin. We end with a biblical nod - “go forth and diversify”. You know it makes sense!
For more information on diversification and for help with your investment planning, contact Kellands.