What is diversification?

Binyamin Ghaffar

Digital Marketing Apprentice

June 2, 2021

Investing has become increasingly accessible and it’s now more popular than ever. According to a 2020 survey taken by Finder, 33% of Brits invest (own shares) so we’re here to talk about ‘diversification’ and let you know how it can help you to reduce your risk in the long term.

The term ‘diversification’ is something that you probably hear a lot, and you may know what it means if you’re an investor, however, for those of you that don’t know what it means, we’ll be talking about what the term ‘diversification’ means and how it can be beneficial in the long term for your investment portfolio.  

What is the meaning of diversification?

The word ‘diversification’ is used in investing quite frequently and it’s quite an important term to understand if you do want to start investing. It simply means to spread out your money into different assets whenever you’re investing. Whether that’s in stocks, property or any other assets. By spreading out your capital (money) into different investment products, it reduces and smoothens out any large risk if one of your assets was to lose a large percentage of its value as your money would be split into various other investment products too. The phrase “don’t put all your eggs into one basket” is a good way to think about diversification.

What is a diversified portfolio?

Now that we understand what diversification means, it’s time to understand how it affects your investment portfolio. A portfolio is a collection of assets that your money is invested in. For example, you could have a portfolio that invests in 10 stocks and 2 properties. A portfolio is just the name for your collection of assets. By spreading your money into different investment products (stocks and property), you are diversifying your portfolio.  

As previously mentioned, if you were to spread your investment into a number of different products, you’ll be protecting your capital (money) from falling in value too much if one of your investment products was to make a loss. This is why it is recommended to split your money into different financial products, so that one negative event doesn’t have a major effect on your capital.

Here’s an example of what we mean when we say ‘don’t put all your eggs into one basket’ –  

If you were to invest all of your savings of £5,000 into one company, let’s say Amazon, and the next month it was announced on the news that their sales were down and their share value fell by 10%. Your shares are now worth £4,500 and you’ve ‘lost’ £500. At this point, you can either sell your shares and take the loss or hope that the company recovers before selling at a profit.

However, your friend, Alex also invested their savings of £5,000 at the same time, but Alex decided to invest into three companies instead: Amazon, Starbucks and McDonalds. When the news about Amazon was released, Alex's shares in Amazon also dropped 10%. However, because only a third of Alex's money was Invested into Amazon, it resulted in their losses being a lot lower at £166, compared to the £500 loss you made by investing all your money into one stock.

The importance of diversification in reducing investment risk

By spreading your money (eggs) across different investments (baskets), you are reducing the risk of your overall portfolio. If one investment falls, the others may rise and the impact of one investment falling will have less of an impact on your overall portfolio.

Remember, when investing, your capital is at risk and you can lose the money you originally invested.

What are the benefits of diversifying your investments?

When diversifying your investment portfolio, there are a number of benefits it provides. Here are some of the key benefits that come with diversifying your portfolio:

  • Reduces the impact of market volatility.
  • It helps to spread your risk which gives you peace of mind.
  • It can help you achieve your long-term financial goals.

Diversification is a great investment strategy used by both beginners and professionals in the investing world. Relying on just one asset is risky and can’t be counted on to perform well, which is why spreading out your investments into a variety of assets can help reduce the impact of a major loss in any one asset and help you reach those long-term financial goals.

Our investment portfolios

At OpenMoney we offer our customers ready-made investment portfolios that are recommended to you based upon your capacity for risk and your financial goals for the future. Each of our investment portfolios consists of more than 15,000 companies which makes them extremely diversified. Read our blog to find out exactly what our investment portfolios are made up of.

As well as offering a diversified portfolio, our fees are very low, which allows you to invest more of your money. Our annual fees for managing an investment portfolio are 0.5% or less, meaning you will be paying 50p or less for every £100 invested. If you want to find out if investing is right for you, take our financial health check.

Whenever you’re investing into investment products, it’s no doubt that risk will be involved no matter how diversified your portfolio is. Always make sure to only invest what you can afford to lose.

*When investing, your capital is at risk. Fees correct as of 21/05/2021 and may exceed the stated value.