Diversifying – the smart way to save and invest
Diversification – spreading your money between different kinds of investments (called ‘asset classes’) and different kinds of investment product – helps reduce the risk of your overall investments (referred to as your ‘portfolio’) under-performing or losing money. This guide will show you how it’s done.
Beyond cash – diversifying across investments
The key to diversifying – and successful investing in general – is to spread your money across different kinds of investments, called asset classes.
The main asset classes are set out below – with the first four being the most common.
||Examples and comments
||Savings and current account balances, savings bonds, premium bonds and other NS&I products, Cash ISAs and any cash you have at home.
||Low – but your money’s buying power is eroded over time if inflation is higher than the interest rates paid. Cash you put into authorised UK banks or building societies is protected by the Financial Services Compensation Scheme up to £85,000.
Fixed interest securities – also called bonds. Essentially a loan to a company or government for a fixed period.
||Gilts (Government bonds), overseas bonds, local authority bonds and corporate bonds (loans to companies).
||Relatively low and returns predictable if held to maturity, however traded prices can be volatile. Your money’s buying power can still be eroded over time if inflation is higher than the interest rate paid on the bond.
Shares – also known as ‘equities’. A stake in a company.
||You can hold shares directly or through an investment fund where you pool your money with other people’s, like with a unit trust, OEIC (open-ended investment company) or life fund.
||Investing in a single company is high risk. Investing in a fund provides more diversification, but risk levels will depend on the type of shares in the fund.
||Includes residential or commercial property and buy-to-lets, and investments in property companies or funds.
||Price can vary and be more volatile than with bonds. Potential for gains but also losses. You might not be able to access your capital quickly if you have invested into property directly. Access to capital might also be restricted through property funds if closed to redemptions, meaning you will not have access until the redemption restriction has been lifted.
||Includes gold, art, antiques, collectibles, fine wines and other investments that do not fall into the four main asset classes.
||Risk profile unpredictable - very much depends on prevailing (niche) market conditions and quality of asset.
1 Cash you put into UK banks or building societies (that are authorised by the Prudential Regulation Authority) is protected by the Financial Services Compensation Scheme (FSCS). The FSCS savings protection limit is £85,000 (or £170,000 for joint accounts) per authorised firm.
It is worth noting that some banking brands are part of the same authorised firm.
If you have more than the limit within the same bank, or authorised firm, it’s a good idea to move the excess to make sure your money is protected.
Each kind of asset behaves differently. For example, when stock prices fall, the prices of fixed interest securities might go up.
If you have a mix of investments in your portfolio it will minimise the risk that they’ll all lose value at the same time.
Diversifying within an asset class
There are many opportunities for diversification, even within a single kind of investment.
For example, with shares, you can spread your investments between:
- Large and small companies
- The UK and overseas markets
- Different sectors (industrials, financials, oils etc)
Do you need to improve your diversification?
You might see from your list of investments that your portfolio is too heavily concentrated in one area.
Here are some common problems to look out for:
- If all your cash is in a single savings account, you should think about spreading it between an instant access savings account and other alternatives, like cash bonds or an investment fund. You should also think about moving some of it where your cash within one particular UK bank or building society exceeds the FSCS protection limit of £85,000.
- If you have a lot of cash – more than six months’ worth of living expenses – you might consider putting some of that excess into investments like shares and fixed interest securities, especially if you’re looking to invest your money for at least five years and are unlikely to require access to your capital during that time.
- If you’re heavily invested in a single company’s shares – perhaps your employer – start looking for ways to add diversification.
Consider your appetite for risk
While diversification is important, you should keep in mind how much risk you’re prepared to accept on your money.
If it is important to you to avoid losses, you might want a portfolio that has less in shares and more in cash and fixed interest securities held to maturity, for example.
Do you need financial advice?
If the changes you need to make to your portfolio are complex, or you want more help understanding risk and diversification, consider getting help from a financial adviser.
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