Five tips for diversifying your portfolio
- Leanne Lancaster
- 31 March 2023
- 10 mins reading time
It’s important to understand why we believe diversification is a must when aiming to minimise risks while investing for the long-term. A diversified portfolio could help your overall portfolio to weather the storm of possible volatility in markets, providing the best balance for your investments.
Read more:The importance of diversification
Here are five tips for diversifying your portfolio:
Don’t put all your eggs in one basket
This is the fundamental rule when it comes to diversifying your portfolio. The most common types of investment are stocks and bonds. Stocks (also known as equities) are shares in a company and tend to be deemed as high-risk but with the potential of high returns. On the other hand, bonds are a lower risk investment that pay a steady, fixed rate of return in the form of interest. To minimise your risk exposure, it may be best to spread your money between these two types of investments. The trick is to find the right balance between risk and potential growth.
The mix of asset classes (the type of investment, for example, bonds, shares or property) that are appropriate to you will depend on your individual circumstances and your financial goals. A good financial adviser can offer insights into which blend of investments could be right for you based on your financial planning needs.
Generally, the younger you are, the more risk you can afford to take as you are able to invest for a longer period therefore smoothing out any market volatility. This may mean that you choose to invest a higher percentage of your portfolio in stocks that, as a rule, offer higher returns.
In contrast, if you are older, you may choose to reduce your risk exposure by investing in a higher proportion of bonds rather than stocks and shares.
Invest in bonds
As mentioned above, bonds could help you to diversify your portfolio while offering the potential to generate a steady income stream and which could be beneficial during a stock market downturn.
Bonds are a type of investment where a government or company borrows money from investors. Generally speaking, the investor who buys the bond is entitled to regular interest payments (known as coupons) and the return of the nominal value (or face value) of the bond once the lifespan of the bond is complete. Bonds are commonly referred to as fixed income securities.
The two main types of bonds are:
Government bonds are issued by governments and are known as ‘gilts’ in the UK. Most gilts have a fixed coupon (regular payments), but some are index-linked to the Retail Prices Index (RPI), for example, and as a result may offer protection against inflation. These tend to be classed as lower risk.
Corporate bonds (also known as ‘non-gilts’) are issued by companies and banks and are generally higher risk than gilts.
The price of bonds is primarily affected by interest rates. When interest rates rise above the coupon rate of the bond, the demand for the bonds reduces as they are less attractive and therefore the price will fall.
This reinforces the importance of diversifying your portfolio with a mix of different asset classes.
As the old saying goes, we believe it’s about time in the market – not timing the market – when it comes to investing. Staying invested has paid off historically: although as with all investments nothing is certain, it can be costly to try and second guess when to come in and out of investments.
At Schroders Personal Wealth we recommend investing for at least five years, so it’s more a case of investing and then forgetting about it. This can be easier said than done, but a good financial adviser can be a source of reassurance during periods of stock market volatility. Remaining invested could be the key to helping you achieve your long-term financial goals.
Before investing you should understand that financial markets are difficult to predict and can change direction very quickly.
Being disciplined in your investment approach and not reacting to short-term market movements could pay off in the long-term. We often refer to the ‘rollercoaster of emotions’ that go hand in hand with investing. Having a knee-jerk reaction to a downturn in markets and choosing to sell out of them could be detrimental to potential returns. Sometimes, by the time confidence has returned and a decision has been made to buy back in, markets may have already bounced back. This means that the ‘best investment days’ may have been missed.
It's worth remembering to focus on the longer term and to try not to get distracted by short-term bumps in the road.
Review your investments regularly
Once investments are in place, it’s good practice to review your portfolio regularly to check whether you’re still on track to meet your financial goals. By taking into account your plans for the future and major life milestones that are coming up, you can decide whether any changes need to be made.
The value of investments and the income from them can fall as well as rise and the investor may not get back the initial investment.
Any views expressed are our in-house views as at the time of publishing.
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