Diversifying your investments

There are many different assets in which you can invest, each with different risk characteristics. While the risks attributable to assets cannot be avoided, when managed collectively as part of a diversified portfolioDiversificationThe spreading of investment funds among classes of securities and localities in order to distribute and control risk., they can be diluted.

The main assets available are shares, bonds (also referred to as 'fixed interest'Fixed interestReferring to income which remains constant and does not fluctuate, such as income derived from bonds, annuities etc. Any debt security which has a fixed flow of income is known as a fixed interest security.), cash and property. Their different risk/return characteristics are broadly illustrated in the graph below.

Asset risk/return characteristics

While individual assets have a bearing on the overall level of risk you are exposed to, the correlation between the assets has an even greater bearing. The aim is to select assets that behave in different ways; the theory being that when one is underperforming, the other is ‘outperforming’. Fixed interest investments and property, for example, behave differently to share-based investments by offering lower, more consistent returns. This provides a ‘safety net’ by diversifying away many of the risks associated with reliance upon one particular asset.

Investment funds

Keeping track of lots of individual assets can be a daunting task. A much simpler solution is to buy investment funds containing those assets and leave the diversification worries to professional management. As explained in our investment funds section, by purchasing a fund that invests in, say, large blue chip companies, another that invests in smaller growth companies and others that invest overseas you can easily spread investments across hundreds of different assetsAssetsItems that are owned by an individual such as property and investments etc. Money in a bank or building society account is known as liquid assets..

Company specific risk

Your financial adviser will tell you one of the best things you can do is to diversify within assets. For example, you can spread your investments into different shares or bonds to ensure your portfolioPortfolioThe collection of investment holdings of a particular investor usually with reference to its composition ie the mix of different classes of securities, such as bonds, property, shares and cash, or if in a single asset class, the mix of different sectors and stocks. is exposed to lots of different types of investments rather than, for example, having shares in just a few large companies. That way share-specific risk can be reduced should one of those companies experience difficulties.

Sector exposure

It is just as important to spread your investments across different sectorsSector A sector is a grouping of funds with a similar investment objective and make up.

An area of the economy where businesses share the same or a related product or service, for example, pharmaceuticals, telecommunications or retail. as well as different companies. Companies are classified by the sector in which they reside, which is dependent on the goods or services they sell or provide. BT, for example, resides in the Telecommunications sector and Shell in the Oil and Gas sector.

For many reasons, companies within different sectors perform in very different ways. By diversifying across sectors you can access shares with high growth expectations, without over-exposing your portfolio as a whole to undue risk.

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