Why balance your investments?
The process of balancing your investments, sometimes known as asset allocation, considers the split between different assets, such as cash, bonds, and shares.
This practice helps to spread risk through diversification – in other words, by not putting all your eggs in one basket.
The types of assets you hold and the proportion of your portfolio devoted to each, also affects your investments’ potential for growth and the risk you’re taking on.
Here we explain how to pick the assets to help you reach your investment goals.
Please note that this article is for information purposes only and does not constitute advice. Please refer to the particular terms and conditions of an investment platform before committing to any financial products.
What is diversification?
To benefit from diversification, you need to invest in assets that behave differently from each other.
Each asset type has a relationship with others:
- high correlation – prices tend to rise or fall in tandem. Could include shares in industries that are closely related.
- low correlation – very little or no relation to each other. Has often included shares and government bonds, particularly when they’re in different countries.
- negative correlation – meaning that they move in opposite ways to each other. Gold, for instance, often increases in price whilst stock markets fall.
Diversifying your assets helps spread risk because you’re reducing the likely potential for losses. If you had all of your money invested in one asset, sector or region, and it began to drop in value, your investments would suffer.
By investing in assets that aren’t related to each other, while one part of your investment portfolio is falling in value, the others aren’t going the same way. Some assets will actually go up in value when others decrease.
Can you be too diversified?
Diversification helps lessen what’s known as unsystematic risk, such as drops in the value of certain investment sectors, regions or asset types in general.
But there are some events and risks that diversification can’t help with, known as systemic risks. These include interest rates, inflation, wars and recession. It’s rare that all asset classes go down at the same time, although the credit crisis in 2008 shows that, on occasion, this can happen.
Nor does diversification mean holding every type of asset, or an equal proportion of assets. Diversification should be balanced with your investment goals.
How can I diversify my portfolio?
Step 1: Choose a range of assets
Different asset classes behave in different ways, and you can invest in a range of types of investments:
In general, the more risk you’re comfortable taking in on, and the longer you have to invest, the higher the proportion of equities in your portfolio.
A portfolio entirely formed of equities has the potential to achieve high returns and beat inflation, but could see sharper falls.
Whereas a portfolio with a greater proportion of bonds and cash will be lower risk, but leave your money vulnerable to being eroded by inflation.
Some of the most volatile assets, like crypto and commodities, are not likely to be a good way to balance your portfolio as they’ll add a lot of risk.
Step 2: Choose a range of companies
Investing in one or even just a handful of companies will make your portfolio more vulnerable to localised issues. For example, a scandal related to a single brand could result in serious losses if it’s the only thing you’re invested in.
Spreading your money across different companies would limit this risk.
One of the best ways to do this is via an investment fund, exchange-traded fund, or investment trust.
They will invest in a basket of different shares, bonds, properties or currencies to spread risk around. In the case of equities, this might be 40 to 60 shares in one country, stock market or sector.
With a bond fund, you might be invested in as many as 200 different bonds. This will be much more cost-effective than recreating it on your own and will help diversify your portfolio.
Do make sure that the funds you hold actually own different shares. You don’t want to end up buying the same company through several different funds, which wouldn’t help you diversify at all.
Step 3: Diversifying by sector
Specific industry sectors can be hit by a range of events, including disruptive innovations such as AI.
Investing in different sectors and industries, preferably those that aren’t highly correlated to each other, can soften this impact on your investments.
For example, if the healthcare sector suffers a downturn, this will not necessarily have an impact on the precious metals sector. This helps to make sure your portfolio is protected from dips in certain industries.
Some investors will populate their portfolios with individual company shares directly, but others will gain access to different sectors through equity funds and investment trusts.
Step 4: Spread your investments across the world
Imagine you had heavily invested in Russia, where the main stock market index rose steadily in the late 2010s.
Then in 2022 Russia invaded Ukraine, and the market crashed.
Investing in different regions and countries can reduce the impact of stock market movements. This means that you’re not just affected by the economic conditions of one country and one government’s economic policies.
However, the Russia example is also a warning that diversifying into certain geographical regions can add extra risk to your investment.
Developed markets, such as the UK, US, Europe and Japan, aren’t as volatile as those in emerging markets like Russia, Brazil, China and India. Investing abroad can help you diversify, but you need to be comfortable with the levels of risk involved.
If you invest in a global fund, it’s worth checking the holdings (i.e. what investments make up the fund) to see if they are duplicating any other funds you’re invested in. Often global funds have a larger percentage invested in the US, for example.
How should I split my portfolio?
Determining the right asset allocation depends on how much time you have to invest, how much growth you need to achieve to meet your financial goals and how much risk you’re comfortable taking to achieve that growth.
Crucially, your investments should reflect how much you can afford to realistically lose if the markets fall.
If you’re still not sure about where to start, you don’t need to make all the decisions yourself; a financial adviser can help turn your aims and broader financial situation into holistic investment decisions.
Alternatively, ‘do-it-for-me’ (otherwise called robo-adviser) investment platforms use questionnaires to understand you and suggest a ready-made portfolio of funds.
If you do understand your appetite for risk, but don’t want to spend time on research, DIY investment platforms offer blended funds (funds that hold other funds) designed for specific appetites for risk.
- Find out more: best investment platforms
When should I change my asset allocation?
The most common reason for changing your asset allocation is a change in your time horizon. For example, most people investing for retirement hold less in equities and more in bonds and cash as they get closer to accessing their pension.
You may also need to change your asset allocation if there’s a change in your risk tolerance, financial situation or your financial goals.
This information does not constitute financial advice, but can act as a helpful starting point for a conversation with a financial adviser.
- Find out more: how to find a financial adviser
