Fair Investment Company's associate director Oliver Roylance-Smith discusses how multi-asset investing affects risk.
When it comes to investing, risk is a key consideration for any investor.
There are many different asset classes and sectors in which you can choose to invest, each possessing different risk characteristics, but the key is not to put all your eggs in one basket.
Here lie the fundamentals of diversification – spreading an investment across a wide range of asset classes and sectors thereby avoiding the risk that your portfolio will be overly reliant upon the performance of one particular asset.
The single best way to diversify your investments is to spread the risk across several different asset types. The principle choice is between cash, bonds, equities and property but within each there can be further division with each class having different risk/return characteristics, as illustrated in the simplistic graph shown above.
By spreading investment between different asset types such as these, the investor diversifies away many of the risks associated with the reliance upon one particular asset – this is the key concept of diversification.
However, diversifying is not only about assets and sectors; it can be achieved geographically too.
It might feel better to invest most of your portfolio in the UK – but is it the most sensible option? This may be fine if you picked the right market and the right assets, at the right time. But is that realistic? Probably not.
A look at the best and worst performing markets and asset classes over recent years shows how asset performance changes from year to year. For example, UK property was a top performing sector in 2002, only for it to sit below seven other sectors in 2003, as UK small cap shares, and other areas, had a good year.
To be able to invest in the ‘winners’ and avoid the ‘losers’ year to year would indeed lead to powerful performance, but it is hard to spot these before they happen.
Finally, it is important to remember that in recent years, the correlation between the returns on different asset classes has been different and that economic growth affects these in different ways.
Therefore, the case for diversifying across asset classes is now more compelling than ever.
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No news, feature article or comment should be seen as a personal recommendation to invest.
The value of investments and income from them can fall as well as rise and you may not get back the full amount invested. Different types of investment carry different levels of risk and may not be suitable for all investors. Past performance should not be read as a guide to future performance.
If you are in any doubt as to the suitability of a particular investment, both in respect of its objectives and its risk profile, you should seek independent financial advice.
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