The quotation is from what the hugely successful investment guru Warren Buffet has described as “by far the best book on investing ever written”. The author was a university lecturer called Benjamin Graham – someone who Buffet acknowledges was one of his early mentors. We have seen how unexpected events can impact on investment markets – with Brexit, Donald Trump’s election to the US Presidency, the run up to the French Presidential polls and Theresa May calling a surprise UK general election. With the lesson of uncertainty in mind, how can we arrange our investments to cope with future uncertainty? Another very successful investor, Sir John Templeton, who was “arguably the greatest global stock picker of the century,” according to Money Magazine, said that “to avoid having all your eggs in the wrong basket at the wrong time, every investor should diversify”.
What is diversification?
The aim of diversification is to create a set of investments – a portfolio – that includes a range of types of assets that will behave in different ways whenever events occur. So as an extreme example, if you were to invest all your money in the shares of a single company, the risk would be very high. You would do really well if it prospered, and really badly if it encountered difficulties. But by investing in several different companies – preferably in different industries and economies – you would reduce the risk. When some shares might disappoint, others could be doing well and the risk would be much lower. Of course in worldwide booms and recessions, almost all companies in all markets will move together – at least to some extent. In the 2008/09 crash, most markets turned sharply downwards, while in the subsequent years, there has been a general if sometimes uneven recovery. Talk to us about your investments
A sound strategy, therefore, is to diversify into a range of other assets as well as shares, in particular bonds and cash. Bonds are fixed interest investments like gilts (loans to the UK government) and corporate bonds (loans to companies). These types of assets are less volatile than shares: they lose less value than shares when times are tough and may even grow at such moments. But the scope for growth from bonds and cash is normally rather less than from shares – although this is by no means always the case.
Risk vs return
The more you are prepared to take on risk, the more you should expect to be rewarded for it – at least in the longer term – although this is not guaranteed. Likewise, where you are not likely to lose money, the returns are mostly relatively low. Cash, for example, is currently generating very low returns, especially after
taking into account tax and inflation. And the position is much the same for short-dated bonds (i.e. where the capital is due to be redeemed in less than five years). At the core of your portfolio is likely to be equity funds that hold shares in a range of different companies, as well as bond funds that hold government and corporate fixed interest investments.
Right Mix of Investments
The mix will depend on your ability to cope financially – and also psychologically – with fluctuating markets. But there are other types of assets that can provide diversification. Property funds do not necessarily move in line with either shares or bonds. Nor generally do commodities and absolute return funds (where the managers aim to provide positive returns in all market conditions – at least in the medium term). Working with you to decide on the right mix of investments to meet your aims and approach to risk is at the centre of what we do. Contact us
The Financial Conduct Authority does not regulate tax advice. Tax laws can change. The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investing in shares should be regarded as a long term investment and should fit with your overall attitude to risk and financial circumstances.