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In early August 2024, there’s a chance you saw headlines detailing a sudden period of stock market decline.
In a matter of days, Google Finance reveals that the S&P 500 index fell from 5,522 points on 31 July 2024 to 5,186 by 5 August, while the FTSE 100 fell from 8,368 to 8,008 during the same period.
Short-term market declines such as these can be unnerving, especially when it appears that your hard-earned wealth is on the line.
However, during times of uncertainty, one of the most effective strategies for maintaining a sense of control and continuing to work towards your long-term financial goals is through diversification.
Simply put, diversification means spreading your investments across various asset classes, sectors, and geographical areas. This approach could allow your portfolio to weather periods of uncertainty more easily.
Continue reading to discover some of the many benefits of diversification, and how it could help safeguard your portfolio while offering opportunities for growth, too.
Diversification could help you minimise risk
Markets are inherently unpredictable, partly because investors react poorly to uncertainty. Economic downturns, global crises, and political events – including the upcoming US election, which you can read about in our new article – can all affect the value of your investments.
Diversification could help mitigate the level of risk your portfolio is exposed to by spreading your investments across various areas, so a decline in one might be offset by growth in another.
For instance, the airline industry was severely affected by the Covid-19 pandemic, and while some have recovered, many companies are still worth far less than they were before the pandemic.
In fact, Google Finance shows that after falling from £12.70 on 21 February 2020 to £4.00 by 3 April of the same year, the popular airline, easyJet, has only risen to £5.21 as of 19 September 2024.
If you had been invested solely in airline companies at the start of 2020, you might have suffered significant losses that still affect your portfolio today. Meanwhile, if you had also been invested in tech companies, which have performed exceptionally well over the last few years, these gains could have cushioned the blow from the struggling airline sector.
While this is just one example, it demonstrates the importance of diversification for managing risk and weathering any “market storms”.
You could consolidate your gains for the future
As you approach key financial milestones in your life, such as retirement, the way you manage your portfolio might change.
Indeed, during the earlier stages of your career, your focus would likely be on growth as you have more time to ride out periods of volatility. As you get closer to decumulation, consolidating any gains becomes more of a priority.
If your portfolio is heavily weighted towards one sector or asset class, you may risk losing a significant portion of your wealth if that area underperforms over the short term.
For instance, if you were nearing retirement with a portfolio concentrated on energy, and that sector experienced a sudden downturn, you may not have enough time to recover from these losses before you need to start withdrawing funds.
On the other hand, a diversified portfolio could minimise the risk of this happening. By spreading your investments across various sectors or asset classes, you could reduce the risk of losing any accumulated gains, offering you peace of mind as you prepare for the next phase of your life.
You could limit “home bias”
“Home bias” is the tendency to focus too much on familiar domestic markets, often leading to an under-diversified portfolio.
It is somewhat natural to harbour home bias, as you may feel more comfortable investing in companies and funds you recognise. However, this approach could expose you to unnecessary risks and limit your growth potential.
Home bias is more common than you might think. Barclays reveals that although the UK only makes up around 4% of the global stock market, British investors typically allocate 25% of their portfolio to domestic holdings. This approach not only reduces your exposure to a broad range of opportunities in global markets, but also increases the risk that your portfolio could lose value if the UK market underperforms.
Take, for example, the performance of various stock market indices in 2020 – a tumultuous year to say the least.
According to JP Morgan, the UK FTSE All-Share index saw a negative return of -9.8% that year, whereas Asian, European, US, and emerging market indices all posted positive growth.
So, if your portfolio had been too heavily weighted in UK funds when the pandemic arose, your wealth could have been overexposed to the downturn in UK markets.
Prioritising diversification could ensure that you benefit from particularly profitable surges in markets around the world and protect your portfolio (where possible) from intense downswings, too.
Get in touch to work with a qualified investment expert
If you want to know more about how a diversified portfolio can help you reach your long-term financial goals, then please get in touch today.
Email info@athertonyork.co.uk or call us on 0208 882 2979 to find out how we can help.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
The value of your investments (and any income from them) 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.
Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
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