What is diversification?

You may have heard the saying about not putting all your eggs in one basket. Instead of investing all your money in a single company, sector or market, diversification means that you spread the risk by having a range of investments. So, if one part of your portfolio performs badly, others may do better and help balance things out.

It doesn’t mean you won’t experience losses though, as diversification can’t prevent markets from falling. But it can soften the impact, because it’s unlikely that all investments will fall by the same amount at the same time.

Think of it like packing for unpredictable weather. You can’t control if it will rain, but bringing a coat and umbrella means you’re better prepared for whatever happens.

Having a diversified portfolio is one of the investing basics for beginners. And there are different types of diversification, including asset classes, sectors and markets.

Asset classes

One of the most important ways to diversify is across asset classes, which are different types of investments that tend to behave in different ways such as:

Shares: ownership in companies.

Bonds: loans to governments or companies.

Property: commercial or residential real estate.

Cash: savings or money market funds.

Commodities: products like oil or gold.

Each asset class reacts differently to economic events, interest rates and inflation.

Sectors

Companies in different industries are affected by different things, so if one sector struggles, others may continue to perform well. Common sectors many tend to invest in are technology, healthcare, energy and finance. 

Geography

Markets around the world behave differently. Investing across regions, such as the UK, US, Europe and emerging markets, means you’re not dependent on a single country or economy.

Different investments perform well at different times. Shares might do well when the economy is growing, while bonds can potentially hold up better during periods of uncertainty. Property, cash and other assets each behave differently too.

Even investments that are considered “good” can go through periods of poor performance. If all your money is tied up in one area, the ups and downs can feel more extreme.

Plus, when market conditions are smoother, it’s often easier to stay calm and avoid making decisions based on short-term market movements.

More isn’t always better. Having lots of investments doesn't necessarily reduce risk and can make your portfolio harder to manage.

If you’re at the start of your investing journey, funds and ETFs can be an easy way to diversify. Some funds can hold hundreds or even thousands of investments across asset classes, sectors and regions.

And try not to have overlapping investments. For example, investing in several funds that all focus mainly on large US tech companies would mean most of your risk is concentrated in one area.

A diversified portfolio will look different for everyone. One of the main factors is how much risk you’re comfortable taking.

A common way to adjust risk is by changing how much of your portfolio is invested in different asset classes, especially shares and bonds. Here are some simple examples:

Lower risk

• More in bonds and cash/money markets, which tend to be more stable
• Less in shares, which can be more volatile

Moderate risk

• A balance between shares and bonds
• Some exposure to property and other assets, such as commodities

Higher risk

• More in shares for higher growth potential, but more ups and downs
• Less in bonds and cash

You might also see smaller allocations to assets like property or commodities to add further diversification.

Diversification can help manage risk and smooth returns over time but it’s important to remember that all investments can fall in value, especially in the short term.