Eggs in baskets. Hedging your bets. Playing the odds. There are a million-and-one different metaphors when it comes talking about diversification.
My personal favourite is how the diversification tips and tricks of investing are remarkably similar to building a strong fantasy football team; pick the best players you can find, make sure they each have a role to play, and only switch them up when they've done as much as you think they can for your team.
One big-name striker does not guarantee a successful team. Out of hundreds of thousands of possibilities, the odds of you selecting the perfect investment that delivers each year are against you. This is where diversification across investment types such as stocks, bonds, property and even plain old cash as well as diversification across geographies can help propel your portfolio into the big leagues.
Building a strong foundation of reliable investments could help ensure that even when a sector or market doesn’t perform as well as you thought it might, the hit to your portfolio is not as bad as it might have been. Similarly, spreading your risk across investments could reduce volatility – the constant ups and downs of markets which can make many investors nervous about their portfolio – and help keep you invested for the longer term.
We all know how tempting it can be to stick to the comfort zone of choosing players from the team you know and love the most. In investing terms, this might mean going with the big name UK stocks with which we’re already very familiar. But this bias to your 'home team' can prevent you from gaining the benefits of potentially high-performing investments found overseas.
To take some of the different stock markets as an example, the UK’s FTSE All Share index has had a very successful run over the past decade but investors who chose to put their stock investments in just this market would have missed out on the stellar run of the US market – perhaps through a US-focused index such as the S&P 500. Investing internationally would also give you exposure to movements in the exchange rates, however this could be a benefit or disadvantage to your money depending on these move in relation to your home currency.
Snap decisions can be both an investor’s and a team manager’s worst enemy. After a rough couple of weeks or months, we have to resist the temptation to cut our losses and drop the underperforming player or investment from our roster. If the reasons you had for adding that player to your line-up are still as valid now as they were before then there could be more benefit in staying the course rather than taking the loss here and now. Similarly, just because a stock has had a great short-term track record, that is not necessarily a justification for adding it to your portfolio and jumping on the bandwagon.
Reassess and rebalance your investment and team strategy alike from time to time, but stay disciplined and remain true to whatever strategy you choose to follow.
Please remember past performance is not a guide to future returns.
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