Diversification can be a great way to ride out turbulent stock market periods

5 things you need to know about Diversification

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It may just sound like a bit of boring investing jargon, but diversification is one of the essential ingredients to successful long-term growth of your investments, and a great way to help smooth out the bumps.

 

  • The simplest and neatest illustration for diversification is the old adage ‘don’t put all of your eggs in one basket’. The meaning, of course, is if something goes wrong, you lose all of your eggs. Think of your money as the eggs, and the basket as a company stock. If that company runs into trouble, your shares could dive in value, leaving you with little more than scrambled eggs.

 

  • In essence, diversification means spreading your money out across as many different (hence, diverse) investments as possible. That could mean 50, 500, or 5000. There’s no magic number as such, many believe the more the better, as far as your money will stretch.

 

  • Diversification also helps you manage risk. If you invest everything in shares in UK companies, for example, you will be exposing yourself to arguably more risk than if you were to buy shares in companies in lots of different countries and markets around the globe. This is because, similar to putting all your eggs in one basket, if something happens in the UK to affect share prices, it could impact all of your investments at once.

 

  • A good diversification strategy might be to ensure you own a good range of investments like stocks, bonds, property, cash equivalents, and maybe some alternatives like commodities, if it suits your risk style. How to choose the right mix of these for your style of risk is known as asset allocation, which can be a science and a full-time job in itself.

 

  • If diversifying sounds like a lot of work, there are shortcuts. Investment funds are like a multipack of investments, so they’re a cheap and convenient way to buy lots at once, rather than individually, which would generally cost more. Funds can contain anything from dozens, to several thousand investments each, so they’re a great way to spread your money around. However, you could argue a fund is still a ‘basket’ of investments, and to get even more diversification, investors should buy a number of them. The good news is there are thousands available, all containing a unique mix of investments from around the world. Better still, if picking funds sounds like a chore, online investment services like Wealthify can select between 10 and 20 funds for you, based on your investment style and manage your investments for you every day for a small annual fee. That way, you’ll have an expertly-diversified set of investments, all in one place!

 

Investments can go down in value and you could receive back less than invested. 

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The comments and opinions expressed in this article are the author's own and should not be taken as financial advice from Wealthify.

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