Smart Investing – Why You Need to Diversify

Smart investors know that they need to diversify to protect against certain risks. It’s the old adage of ‘not putting all your eggs in one basket’. After all if you have all of your funds in only one share you will lose the lot if the investment crashes and burns…scrambled eggs!

There are four main categories of assets and these are: cash, fixed interest, property and shares. Each of these assets behaves differently in different market situations. Another component of diversification is to add international investment.

It has been said on occasion that cash is king. Certainly with markets in such dire straights during the recession this was so. However, cash does not have growth and does not keep up with inflation. But it is part of your overall diversified portfolio.

Fixed interest assets are investments such as bonds. Bonds are a loan to an institution which pays a fixed rate of interest over the life of the bond to the lender (you as investor). This interest does not change over the time of the investment…it is fixed. The face value of the bond is the amount which the borrower has promised to repay at maturity. The value of the bond is affected by market interest rates. If interest rate go up the value of the bond declines…and if interest rates go down the value of the bond goes up. This increase is because the bond is earning more than other investments and as it can be traded on the open market it has more value and more sought after.

Shares are more popular when interest rates are low and the values normally reflect this. When you buy shares you are buying a portion of the company as a part owner. You invest with the hope that your money will grow. Overall shares are more susceptible to market risk and less vulnerable to inflation risk. While it is not often the case there are times when bonds outperform shares.

Including all of the asset classes in your portfolio will give you diversification but you also need to diversify within those asset classes. This means that not only do you need to invest in different shares but within different industries. When investing in property you need to consider commercial as well as residential.

It said that 92% of the return of a portfolio is due to asset allocation (the mix of investments). Get it right! Smart investing means you need to diversify.

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