Diversification

How different investments work

There’s a wide range of investments to choose from, like shares, bonds and funds. Some are more complicated in how they work compared to others, but we’ll go into more detail later.

Shares and bonds can offer diversification as well as suiting different investment goals:

Bonds are typically less risky and usually pay regular income, but their value doesn’t grow as much as shares can.

Shares offer the potential for higher growth but don’t always pay regular dividends. They’re riskier.

Remember though, income and growth isn’t guaranteed.

It’s also important to hold some cash for a rainy day for emergencies, or if you need the money within five years.

More on how much cash you should hold

Learn more about risk

Why sectors are important

You could see sectors as different categories investments are in. They’re usually based on what the company is or where they’re based, or by the type of investment. Both shares and funds can be grouped into sectors, but the sectors used for shares are different from those used for funds.

For example, Lloyds Banking Group shares would be in the Financials sector. Funds usually invest in broader categories to gain diversification so, for example, a fund that invests in multiple countries across the world would be in the global funds sector.

Different sectors perform differently at different times – no one sector will always be on top. That’s why it’s important to hold a mix.

Avoiding over-diversification

While diversification is an investing essential, we shouldn’t always take a ‘the more the merrier’ approach – you can have too much of a good thing.

There’s such a thing as over-diversification. While it reduces the risk from holding too few investments if you hold too many, it can be hard to keep track of their performance. Also, if your funds have similar objectives, you could be holding a lot of the same thing.

The second and third fund you add to your portfolio gives much greater diversification benefits than the 20th.

There’s no magic number for how many holdings you should have but it’s unlikely a portfolio with 20 or more funds is the best option.

Know the costs

Costs don’t just include charges like trading commissions, there’s also the time involved. Most of us have jobs, families and other things to fill our time besides poring over company accounts.

Keeping track of a large share portfolio, and hunting for ideas, can be a full-time job – this is where a fund manager could help. At a certain point, the diversification benefits just don’t justify all that extra effort.

But if you end up investing in numerous actively managed funds to diversify, you could just be creating an expensive tracker fund.

You’ll need to think back to your reasons for investing in the first place and see which funds match those objectives too.

Reviewing and rebalancing your portfolio

Once you’ve built your portfolio, it’s important to check in on your investments from time to time to make sure they’re still right for you. There’s no hard-and-fast rule on how often you need to review your portfolio, but we think twice a year is sensible – once a year at the very least.

Review your investment portfolio