Investing 101: What is Diversification?
Granny’s always right. We could just leave it there, but for those of you wanting a little more justification... we’ll humour you. Amongst the wisdom we treasure, some of dear old Granny’s words still ring true, “don’t put all your eggs in one basket!” 🐣 True say, Granny!
Although Granny may not necessarily be your default source when it comes to advice about the stock market, in this case, it’s a solid steer 👍 The word ‘diverse’ simply means different, and when it comes to investing strategy, diversification relates to the idea of mixing a wide variety of investments into your portfolio ☯️
What Are the Benefits of Diversifying?
Including a cross-section of different investments in your portfolio is a way to spread risk. The hope being that if the value of some investments go down, these would be counteracted by other investments which have increased in value 📊
Investing money will inherently contain some risk, but diversifying is a means to try and smooth any significant market fluctuations. For example, if you hold a portfolio that is solely comprised of assets from a single industry, and one day some technological change suddenly causes that industry to collapse, then your investment could theoretically be wiped to zero!
So, to try and avoid getting egg on our face, we diversify... and carry them in different baskets 🤔
How Do I Build a Diversified Portfolio?
There are a number of factors to consider when creating a diversified investment portfolio:
- Geography, invest across a variety of countries / financial markets
- Sector, invest in different sectors e.g. healthcare or technology
- Asset Class, invest in a mixture or shares, bonds, property, and precious metals
For most people, an ideal portfolio will have varying degrees of risk and return. Crucially though, your returns will never exceed the best performing asset, and will never be lower than the worst performing asset in your portfolio 📉
Balanced portfolios help limit the ‘worst-case scenario’, so you don't end up losing everything if a particular region, sector, or asset suffers significant losses 😅
How Does Plum Use This Principle?
There’s always an element of risk when investing money, because the value of your investment can go down as well as up. At Plum, we’re all about promoting ways to invest sensibly so that this risk can be minimised wherever possible. Rather than expecting you to pick specific stocks, we’ve done the hard work for you, and instead offer a range of investment ‘funds’ 👨👩👦👦
These funds are professionally managed portfolios containing many different securities (normally a mixture of stocks and bonds). This means the risk is spread, though we pay a fee for management of the funds. However, if one company in the portfolio performs badly, it should only affect a small portion of your overall investment 🧀
If you'd like to learn more about investing with Plum then you can check out our website.
You can get started with Plum investments here (the first month is free 😮).
Remember, your capital is at risk if you choose to invest.