Understanding Risk and the Importance of Diversification

In the last few years, we’ve seen highly volatile markets. Brexit, US-China trade wars, the Coronavirus Pandemic – that’s just to name a few factors that have caused the markets to be so turbulent. 

It’s safe to say we’re in one of the most uncertain situations we’ve been in for a long time.

However, in times like this we are reminded of the importance of understanding risk, diversification, and looking at the long term when it comes to your investments, and we’re going to try and give you a brief insight into this.

What is risk and volatility?

The risk and volatility of your investments is effectively how likely the value of your investments is to change. This means that an investment with a higher volatility, or a riskier investment, is more likely to have bigger changes in its value, which can be either an increase or a decrease. 

Some types of assets are riskier than others. For example, stocks and shares tend to be risker assets than holding bonds. Stocks and shares, being riskier, usually benefit more from when times are good, but suffer more than when times are bad. Bonds are less risky, and usually have less growth but are not as badly impacted by the bad times. So, if you had a portfolio fully invested in shares you are likely to have done well over the last 10 years but suffered this year. Bonds, however, will of likely seen less growth of value over the same 10 years, but will of sheltered you better against falls in value this year. 

Stocks and bonds are only a few types of asset classes, and there are many more with different risk profiles such as commercial property and alternative assets.

What diversification achieves

Diversification is the process of reducing your exposure to any one particular asset or risk. By investing your portfolio in multiple asset classes, such as stocks and bonds, you can reduce the risks you are exposed to. To carry on from the example above, if you had a portfolio with a mix of stocks and bonds, over the 10 years you would of likely seen growth higher than if you held just bonds, and in the last year you would of likely seen a fall in value less severe than if you just held stocks. 

There are multiple types of diversification that we consider when making investments –

Geographical Diversification – the returns in different stock markets can vary considerably. Working out which market will perform best is almost impossible, so having investments in most areas removes the need to predict – or guess – which area will outperform

Sector Diversification – companies selling consumer essentials tend to generate consistent profits, as people will always need things like toothpaste and shampoo. But when the economy slows down, people tend to buy less luxury goods like cars and holidays. Diversifying across different sectors should increase the chance that some of your investments perform well wherever we are in the economic cycle.

Investment Style Diversification – there are many different approaches to fund management. Some managers seek undervalued companies that others have overlooked, while some look for established companies with strong cash flows. Different companies perform well at different times, so it’s always a good idea to have a mixture of investment styles to help achieve more consistent returns.

At Sovereign Wealth in Market Harborough, we seek to provide advice to both individuals and businesses across Northamptonshire and Leicestershire, guiding you towards an investment portfolio that is suitable for you. We offer a wide range of portfolios and investment opportunities, along with a deep understanding of how tax rules and wealth structuring, to help give you the peace of mind that you are investing with confidence.  

The value of an investment through St. James’s Place and any income generated may fall as well as rise. You may get back less than the amount you invested.

If investing is something that are considering, we would be happy to help. You can call us today on 01858 791182 or get in touch.

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We work with many local business owners and directors in Northamptonshire and Leicestershire, helping them and their families to become financially independent.

Whether you are a startup looking to scale or a seasoned business owner planning your next journey, we will take the time to understand your objectives and plan a course of action.

You can call us on 01858 791 182  or email us at the link below.

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