Investing in the stock market can seem like a daunting prospect, especially when markets are volatile and share values are moving sharply up and down.
But not only have equities proven to be the most profitable home for your money over the long term, there are ways to mitigate the risk and make the process far less stressful.
Chief among these is diversification – one of the fundamental principles of a successful investment strategy and something we have been using as a tool for protecting and growing our clients’ assets for over 200 years.
Diversification means spreading your money across different stocks, shares, funds, industrial sectors and even geographical regions. It helps to smooth out performance and minimise risk, whatever the prevailing economic circumstances.
Some of the reasons for diversification are obvious, others are more subtle.
The most obvious reason to spread your investments around is that it reduces volatility and lessens the impact of any one share or asset class performing badly. Imagine ploughing all of your money into one share. If that company went bust you would lose all of your money. However, investing in a broad range of shares means that some can fall in value without having a major impact on your overall performance.
The same is true of geographical regions. As we have seen in the time since Donald Trump became US President, the US market has rocketed to record highs, while other stock markets, such as emerging markets, have been more volatile. Meanwhile, there have been periods in the past when the opposite has been the case. Investing in a spread of assets in different countries helps to capture those that are performing well, while minimising the impact of those that are experiencing a period of underperformance.
Approaches to diversifying
The most common way to spread money around a sufficient range of assets is through investment funds, which typically hold hundreds of different shares.
You can then build a portfolio of different funds that each have a different focus, whether it be an industry sector (tech, for example), geographical region (emerging markets, China or Asia) or investment objective - whether you want to grow your money as much as possible, or whether you need to preserve it to provide an income.
Not only does diversifying reduce risk, it can produce counterbalancing effects which can “even out” performance during volatile periods.
For example, as a general rule, government-issued gilts tend to rise in value when the stock market falls, because investors look for a safe place to park their money and nowhere is safer than government gilts. That demand pushes the price up, and so the profits from gilts help provide a counterbalancing effect to the losses on equities, thereby smoothing out the returns.
Diversifying also creates the opportunity to invest in riskier asset classes.
“A great example is emerging markets” says Rob Burgeman, divisional director and investment manager at Brewin Dolphin. “They are either heroes or zeroes - they can be up 20% one year and down by 15% the next. But by spreading money around different regions and assets, the overall portfolio returns are smoothed out.”
For example, in 2008, the year the financial crisis really took hold, US equities fell by 37% and UK equities plummeted by 29.9%* But shares in advanced emerging markets rose by 30%. A typical Brewin Dolphin balanced portfolio fell by 17.4%, insulating investors from the worst of the falls.
Likewise, in 2014, when UK equities returned only 1.2% and emerging markets returned only 5%, Brewin’s balanced portfolio returned 7.2% because of our exposure to commercial property and the US market, both of which did well that year.
“As you can see, a balanced approach will never achieve the most outstanding returns, but it will give you a smoothed return which makes it far more predictable and, crucially, far less stressful. That means you can get on with your life without worrying about your investments swinging too wildly in value.”
Depending on your investment goals, attitude to risk and timeframe, we can structure a diversified portfolio tailored to meet your personal financial goals, whether that be to grow your money over time or to produce an income for later in life.
The value of investments can fall and you may get back less than you invested.
No investment is suitable in all cases and if you have any doubts as to an investment's suitability then you should contact us. The information contained in this document is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness.
The opinions expressed in this document are not necessarily the views held throughout Brewin Dolphin Ltd. If you invest in currencies other than your own, fluctuations in currency value will mean that the value of your investment will move independently of the underlying asset. Past performance is not a guide to future performance.