What is diversification in investing?

The word ‘diverse’ means different. And when it comes to investing strategy, diversification refers to the practice of mixing a variety of assets into your portfolio.

Why is it good to diversify your investments?

Although in practice, it makes sense to diversify your investments, diversification is something of a compromise.

"Diversification may preserve wealth, but concentration builds wealth." — Warren Buffett

In theory, the ideal investment strategy would be to pick the single, top-performing investment asset and put all our money behind it.

However, in reality, nobody can predict what that star asset will be... And people can lose significant amounts of money in the pursuit of this aim.

This is why we diversify. To hedge our bets. Although it's for each individual to decide for themselves just how far they want to take the principle.

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!

How do I build a diversified portfolio?

There are a number of factors to consider when selecting investments to create a diversified investment portfolio.

1. Geography: include a variety of countries / financial markets
2. Sector: vary the business class e.g. healthcare or technology
3. Asset Class: mix shares, bonds, real estate 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 can the Plum app help me diversify?

There’s always an element of risk when investing money because the value of your investment can go down as well as up. But we designed the Plum investment app to make the process investing more accessible, and we're all about promoting ways to invest sensibly so that this risk can be minimised wherever possible.

If you don't feel confident picking specific stocks, we also 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 the management of these funds. However, if one company in the portfolio performs badly, it should only affect a small portion of your overall investment.

Check out our website if you'd like to learn more about investing with Plum.

If you choose to invest, then please remember that your capital is at risk. You shouldn’t invest in/use any financial product unless you understand its nature and your exposure to risk. If you choose to invest or automate investments, you should be satisfied your choices are suitable for you and your circumstances.