Your coffee break investment plan - Day 6: Having a range of eggs in your basket

No investment is a guaranteed route to riches - but while you can’t eliminate risk completely, you can manage it by having exposure to a broad range of assets. This is known as diversification.

The idea is that losses suffered in one area will be balanced out by gains elsewhere. Should your investments in equities – another name for shares - take a tumble, for example, you would hope that other your holdings, such as commercial property, rise in value.

This helps put a floor under your holdings and limits the risk of losing all your money in difficult periods. If the global financial crisis of 2008 has taught us anything it’s not to have all our financial eggs in one basket as it leaves us too vulnerable.

Proper asset allocation involves having the four main asset classes: equities (shares); bonds  (loans to companies or governments; commercial property (shops, offices and industrial buildings), and cash, as well commodities (such as crude oil, metals, natural gas, and agricultural products). Further diversification can be achieved through exposure to a variety of sectors and regions of the world.

However, a golden rule when allocating to assets is to ignore fashions and trends, points out Andrew Merricks, head of research at Skerritt Consultants. Fashionable investment funds may enjoy short-term periods of stunning performance but these can just as easily come to an abrupt halt.

“Opt instead for managers and funds with sound, longer-term investment goals that offer an acceptable level of risk,” he says. “Marketing firms are good at coming up with branded portfolios so make sure you know what they are trying to achieve.”
For example, unless you have a strong desire to invest in a particular area, such as Latin America, it might be worth opting for a more general global equity fund that will give you exposure to a number of countries and companies.

Of course, even though the value of your investment may fall, a loss is only crystallized when it’s cashed in. Until then it’s only a loss on paper and there is always the possibility that your manager will turn that into a profit.

It’s also important to understand that your asset allocation is likely to change significantly over time as your financial goals change so you need to re-evaluate it regularly.

Darius McDermott, managing director of Chelsea Financial Services says: “When you are younger you’re likely to have a higher proportion of riskier assets as you have the time to ride out volatility in the hope of higher gains. As you get older you are likely to de-risk your portfolio so that your capital is better protected.”

Riskier assets would include a high exposure to equities, especially those focused on more unpredictable parts of the world. Although these offer the potential for higher gains they come with a health warning attached due to the increased risk of volatility – exposure to the ups and downs of the stock market.

Mr McDermott doesn’t believe in the traditional approach of de-risking completely in later life and says some equity exposure is needed. “We are living longer and need to fund our retirements so our portfolios still needs to grow,” he says. “If not we run the risk of running out of money.”

If you missed them, make sure you read the first articles in this series.


Day 1: What is investing?

Day 2: What is the stock market?

Day 3: Setting investment goals

Day 4: The two enemies of investors: Inflation and tax

Day 5: The importance of keeping charges low

Also watch Moneywise editor Moira O’Neill interview Andy Parsons from The Share Centre about why you should start investing.