One of the core pillars of a sound investment strategy is “diversification”. If you’ve ever invested any money, it’s a term you’re likely to have come across.
Essentially, it means “don’t put all your eggs in one basket”. Rather than investing your money in one place, diversification ensures you hold a wide range of assets. They might include:
- Shares, funds, or exchange-traded funds
- Bonds
- Cash
- Property
- Other alternative assets such as commodities or things like antiques or wine.
Diversification can help you to smooth out investment performance and to boost your overall returns. Read on to find out why, and why diversifying by region can be a sound approach.
Diversification lets you spread risk and reduce stress
Imagine you had £1,000 to invest and you decided to use your whole pot to buy Tesco shares. If the retailer performed well, you might receive a return on your investment, and some dividends along the way.
However, if the business didn’t perform well or, in an extreme scenario, went out of business, you’d lose some or all of your £1,000.
It’s also a stressful way to invest, as you’d be forever fretting about small movements in the share price, unsure when to cash in your shares. It’s more speculation than investment.
Imagine instead that you decided to invest your £1,000 in a FTSE 100 tracker fund. Your investment would then follow the fortunes of 100 of the biggest UK-based companies. If Tesco (or, indeed, the retail sector) performed poorly, your losses could be offset by gains by other companies or in other sectors.
You can sit back and relax, safe in the knowledge that you don’t need to worry about share prices every day. Over a period of some years, you would expect the stock market to rise, and your dividends would be reinvested.
Geographical diversification can smooth out regional ups and downs
As well as diversifying across asset classes and sectors, you can also spread your investments over different geographical areas.
The principle is the same. Just because the US or UK stock markets may be struggling doesn’t mean those in China, Japan, Europe or other emerging markets are.
Here’s an example. The table below shows the annual returns of several global stock indices in 2020.
Source: JP Morgan
Had you invested all your money in the UK in 2020 (in the FTSE All-Share index), you’d likely have returned a loss.
However, if you’d spread your investment across different regions, strong gains in Asia, emerging markets, the US, and Japan would likely have offset these losses, and ensured you made a positive return.
The table below demonstrates the performance of six geographically diverse stock market indices between 2012 and 2022. You’ll see that it’s hard to predict which region will outperform others in any individual year. It also demonstrates the power of spreading the risk across the world so profits in one region balance losses or weaker performance elsewhere.
Source: JP Morgan
You can see that no one region or index constantly outperformed any other, and there is only one year where every index ended up in negative territory.
Diversification is even more important in an uncertain climate
2022 was a tricky year for investors. Many stock markets underperformed, most notably in the US where the S&P 500 fell by almost a fifth over the year.
Conversely, it’s interesting to note that, despite months of negative headlines about the UK economy, the FTSE All-Share index actually finished 2022 higher than it started. Read about why the stock market is not the economy in our recent article.
With a difficult 2023 ahead, the importance of diversifying your investments cannot be overstated. 2022 saw the value of a truly diversified approach – not just geographically but in various asset classes – and an uncertain few months ahead mean spreading risk is likely to remain a sensible strategy.
Get in touch
We can help you to build a diversified investment portfolio, aligned with your goals and your tolerance for risk.
To find out more, please get in touch. Email hello@sovereign-ifa.co.uk or call us on 01454 416653.
Please note
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
