The importance of diversification

One of the most effective means of reducing the different types of risk is to diversify your portfolio.

No one type of security, asset class or investment manager provides the best performance over all time periods.

So a range of investments should reduce the risk of each of the investments within a portfolio experiencing drops in performance at the same time.

The importance of diversificationThis is simply because one asset class or manager may perform well to counter the poor performance of another.

Diversification can be implemented in three distinct ways:

  • Across asset classes – The major asset classes perform differently under different market conditions. By investing across a variety of asset classes you may be able to reduce the volatility of your portfolio return.
  • Across markets and regions – Spreading your exposure within each asset class across a wide range of countries, currencies, industries and stocks ensures that your investment is not narrowly concentrated in a particular region or industry. This reduces the impact of a region or industry downturn.
  • Across investment management styles – Different investment management styles tend to excel under different economic and market conditions. By combining a range of investment managers with complementary investment styles you may be able to neutralise the bias to any one style in each asset class.