It’s a strategy that helps to manage risk by investing in vehicles that span different financial instruments, industries, and other categories. By investing in different kinds of assets in your portfolio, you’re essentially aiming to neutralise the impact of poor fund performance by offsetting it against the positive performance of other funds. 

Creating a diversified portfolio is complicated and comes with an obvious drawback; you may be reducing your potential short-term gains and quick wins. But you will be doing so in exchange for greater stability and security and that’s attractive to those who are less adventurous when it comes to investing. 

While diversification is a valuable and effective risk management strategy, some risks are impossible to avoid. These are called systemic or market risks. Here’s a brief explanation of the two main types of risk.

Most fund managers and advisers diversify investments across asset classes and determine what percentage of the portfolio to allocate to each. Such asset classes include:

• Equities – these are shares or stocks in a publicly-traded company.
• Fixed-interest securities – also known as bonds, these represent a loan made by an investor to companies or states. 
• Real estate – this includes buildings, land, natural resources, agriculture, livestock and water or mineral deposits.
• Commodities – these are basic goods necessary for the production of other products or services.
• Cash and short-term cash equivalents – this includes savings, cash ISAs, savings bonds and premium bonds.

Here’s an example of a portfolio with a diversified asset allocation:

A good financial planner will take the time to get to know you so that they can advise you on how much risk you should be exposing yourself to and how you should therefore structure your asset allocation and portfolio. 

As a rule of thumb, the older you are, the less comfortable you’ll be taking risks with your money. After all, you may need to start taking an income to support your preferred lifestyle. However, if you are younger, you may be comfortable taking a higher level of risk as you have more time to allow markets (and therefore your investments), to recover from any downturns. You just need to make sure you understand the risks and are comfortable taking them.

Finally, remember that the value of investments, and any income you take from them, can fall as well as rise, and you may get back less than you invested. Diversification helps mitigate the risks but won’t remove them entirely.