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Why is diversification important to managing investment risk?

 

Don’t put all your eggs in one basket.

 

This clichéd saying is the key principle behind diversification and a fundamental technique in the investment manager’s tool box. Diversification is the act of spreading your money across different types of investment assets. This is done to mitigate risk while trying to maximise returns.

There are several dimensions to diversifying your portfolio, but two major ones are asset class and geographical area.

 

Asset Classes

 

An asset class is a group of investments that tend to react similarly in different market conditions. The main asset classes are equities (stocks and shares), bonds (fixed income), property, commodities and cash. Economic and political changes affect each asset class in different ways.

It is usually a good idea to have a mixture of asset classes. By diversifying a portfolio across different asset types, an investment manager can reduce the negative effect one asset class could have on the whole portfolio.

 

Geographic Area

 

Economic and political behaviour differs between countries, therefore it is important to have a spread of investments across different geographical regions. The two common regions considered are developed and emerging economies. Developed nations tend to have lower potential growth but offer lower volatility compared to emerging economies. A mixture of geographic areas is important for a balanced portfolio. With growing globalisation, geographical areas are becoming more dependent upon one another. This makes it increasingly necessary for investment managers to understand and evaluate these international relationships.

 

But why bother diversifying?

 

The economics and politics of the world are incredibly complicated. Even the most accomplished Investment Manager will not perfectly predict economic and political changes. These changes can positively and negatively impact the value of your investments.

Without diversification, your portfolio could have a high concentration in one investment area. If there was an event that negatively affected that area, there could be a major reduction in the value of your asset(s). Diversifying your portfolio means a negative impact in one area will only have a relatively small effect on the overall portfolio.

 

Tiller’s approach to diversification

 

Upon joining, all our clients must answer an ‘attitude to risk’ questionnaire. From their answers, we determine the level of risk a client is happy to take. We use this risk level to allocate their money across a range of suitable asset classes.

With oversight from our Investment Committee, the underlying investments and target allocations are selected by our algorithm. Once the money has been invested, the portfolio is re-evaluated daily and if the portfolio proportions need adjustments, we re-balance at no cost to our clients.

Test how we could diversify a portfolio for you in our discovery area and explore where your money would be invested.

 

 

Disclaimer:
The views contained herein are not to be taken as a recommendation or advice. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. A mandatory sell of a theme may result in a taxable capital gain or loss. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It is very important to do your own analysis before making any investment based on your own personal circumstances. You should take independent financial advice from a professional in connection with, or independently research and verify, any information that you find on Tiller’s website and wish to rely upon, whether for the purpose of making an investment decision or otherwise. It should be noted that investment involves risks, the value of investments may fluctuate in accordance with market conditions and investors may not get back the full amount invested.


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