“Diversification is the only free lunch in investing.” – Harry Markowitz, Nobel Prize–winning economist.
It’s a famous line, and for good reason. Most things in life come with a cost, but diversification really does give you something valuable without taking much away: it reduces risk without necessarily reducing your expected returns. Let’s break it down into two parts:
1. Diversifying Across Asset Classes
Think of asset classes as different food groups on your investment plate: shares, bonds, cash, property, and so on. Each behaves differently at different times:
- Shares can grow strongly over the long term, but they’re volatile.
- Bonds tend to be steadier, often acting as a cushion when shares fall.
- Cash is safe but loses value to inflation over time.
- Property and alternatives can add another layer of return, sometimes moving independently of stocks and bonds.
By combining these asset classes, you’re not putting all your eggs in one basket. When one stumbles, another may hold up or even do well. That balance helps smooth out the bumps along your journey.
2. Market Diversification: Geography and Sectors
Diversification doesn’t stop at asset classes. Within each asset class – especially shares – you can spread your investments across countries and sectors.
- Geography: Investing only in the UK ties your fortunes to one economy, one currency, and one political system. By holding global funds, you gain exposure to the U.S., Europe, Asia, and emerging markets. Different regions often move in different cycles, which reduces risk.
- Sectors: Companies in technology, healthcare, energy, consumer goods, or finance don’t all rise and fall together. Tech might soar while energy lags, or healthcare could hold steady while consumer goods stumble. A sector mix makes your portfolio less reliant on any single trend.
Why This Matters
The goal isn’t to eliminate risk – that’s impossible in investing. The goal is to avoid being overexposed to one outcome. Diversification helps you capture growth where it happens while reducing the impact of surprises.
Think of it as building resilience: you’re not trying to predict exactly what happens next, but making sure your portfolio can cope with whatever does.
👉 Up next in this series, we’ll look at Passive vs Active strategies – two very different ways to build a diversified portfolio.
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