Understanding diversification

If you’re just getting into investing, you’ll likely have heard the word ‘diversification’ thrown around a few times. But what does it mean? And why is it so important to understand?

What is diversification?

Diversification in the world of investing is when you spread your money into different assets whenever you’re investing. By doing this, it reduces any large risk because if one of your assets lost a large percentage of its value, you wouldn’t lose everything because you’d have money sat in other investment products too. The phrase “don’t put all your eggs into one basket” is a good way to think about diversification.

To give you an example, let’s say you invested all of your savings of £5,000 in one company, Banana Corp. Next month, Banana Corp are in the news because their CEO has been arrested and their stock price plummets 20% (stock prices can be affected by many factors including news). Your shares are now worth £4,000 and you’ve ‘lost’ £1,000. You can either sell your shares and take the loss or hope that the company recovers before selling at a profit.

Your friend Alex also invested their £5,000 savings at the same time, but Alex decided that they’re going to invest in three companies instead; Apple Co, Banana Corp and Cucumber Ltd. When the news about Banana Corp comes out, Alex’s shares also drop 20%. However, as Alex only invested one third (£1,666) of their money in Banana Corp, their 20% losses are much lower - they lost around £333 compared to your £1,000 and their shares are now worth £1,333.

At the same time, Apple Co and Cucumber Ltd both recorded impressive sales over the last quarter and both of their share prices rise 10%. The £1,666 that he invested in both of those companies is now worth around £1,833. This means that Alex’s investments stand at roughly £4,999.

Alex didn’t make a profit, but the diversification of their assets meant that they didn’t feel the effects of the Banana Corp share price change as much as you. That’s the basic principle of diversification. By spreading your bets you are reducing the amount of risk - you could even say hope - you put into one company.

When you diversify your investments, the returns are likely to be lower, but there’s also a less chance of losing all of your money and nobody wants that! As the story goes, slow and steady wins the race.

What is a diversified investment portfolio?

A diversified investment portfolio is a collection of assets that your money is invested in, whether it be stocks, bonds or property. You could create your own portfolio by selecting your own assets, or work with an investment company with a ready-made diversified investment portfolio.

The simplest and quickest way to do it is to invest in a ready-made diversified investment portfolio (like the ones we offer). You will normally pay a fund fee or management fee to a company for this, but you won’t have to do all of the heavy lifting such as researching and monitoring all of your investments. We’ll cover off funds and portfolios in our next section.

What are the fees to invest in a ready-made diversified portfolio?  

The fees you will pay an investment company will differ depending on the company you choose. Some of the common fees you will see when investing are:

  • Investment charges – Charges for the management of your investments including researching and selecting funds.
  • Platform fee – Fees to use the investment platform (website or app).
  • Admin fee – Fees for administration costs such as maintaining records.

When comparing platforms and companies, try and find their total charges figure. This should include all of the charges you face when investing and will allow you to compare investment providers side-by-side. At OpenMoney, we’re proud to have some of the best value fees on the market. We charge no more than 0.76% per year and include ongoing advice, management of your investments and access to our free money management app.

Remember, capital is always at risk when investing.
Fees correct as of 31/08/2022 and may exceed the stated value.

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