Diversification has been called: “the only free ride in investing”.
The main drivers behind long-term investment returns are the amount of risk in a portfolio and the asset allocation used to generate returns. And the investment tool that links risk and asset allocation is: diversification.
Asset Allocation is the process of splitting an investment portfolio between different asset classes – generally company shares, bonds, commercial property, commodities and cash – in a proportion to match an expected level of risk to meet the investors’ needs. Diversification is the process of ensuring that there is a good spread of investments between these assets, but also a good spread of investment within each asset. For example, shares of companies based in different regions and countries; operating in a range of industries; and including companies of different sizes. Each of the asset classes and sub-classes will produce different returns in different economic and market conditions. Diversification helps to reduce the risk to a whole portfolio if one particular asset class, industry or region suffers significant falls.
By using Asset Allocation and Diversification a wealth manager can match a portfolio to an investor’s attitude to risk and long term goals. The outcome should be a smoother ride to the investment destination.