Diversification is the practice of spreading your investments so that your exposure to any one type of asset is limited. This practice is designed to help reduce the volatility of your portfolio over time.
One of the keys to successful investing is learning how to balance your comfort level with risk against your time horizon. Invest your retirement nest egg too conservatively at a young age, and you run the risk that the growth rate of your investments won’t keep pace with inflation. Conversely, if you invest too aggressively when you’re older, you could leave your savings exposed to market volatility, which could erode the value of your assets at an age when you have fewer opportunities to recoup your losses.
One way to balance risk and reward in your investment portfolio is to diversify your assets. This strategy has many complex iterations, but at its root it’s simply about spreading your portfolio across several asset classes. Diversification can help mitigate the risk and volatility in your portfolio, potentially reducing the number and severity of stomach-churning ups and downs. Below you will find the ‘smartie box’ that illustrates the importance of portfolio diversification and regular re-balancing. On its own, each asset class can be quite volatile, but a mix of assets in a balanced portfolio can lower overall volatility.
I therefore take the approach of a well diversified portfolio using quality investment managers and understanding my client’s needs – such as the required return, risk profile and time horizon – all pertinent in determining the correct asset class mix. I believe that it is not timing the market, but time in the market that really counts.