Understanding Diversification

The new tax year begins on the 6th of April each year, a time of year when many people are in the mood for a general clean up of their lives from spring cleaning their homes to decluttering their computer files and reviewing their finances.  As a result, every year, the media, both traditional and online, fills up with article containing advice on all of the above.

While some of this advice can be very good (and some of it can be very bad), none of it is written with you, personally, in mind.  Financial journalists are not financial advisors.  They can’t talk with you, ask you questions and come to understand your particular situation, they can only give general advice on what might be good (or bad) ideas for people at a similar life-stage and with similar income to you.  This means, for example, that while they might cover the general principles of concepts such as diversification, they can’t look at how you, specifically, should diversify.

Diversification is really just a way of managing risk.  Essentially it’s a financial term which means “don’t put all your eggs in one basket”.  While this may seem obvious, the skill is to work out exactly how to divide your nest egg between different baskets so as to have the best chance of meeting your financial goals.  There are four main asset classes for you to choose from.

Cash

There are still lots of uses for cash and it’s often advisable to keep some handy in an easily-accessible form.  In fact, it can be very useful to keep some physical cash in your home (obviously taking security considerations into account) as well as some in an account you can access easily.  Having said that, although the last interest rate rise generated press headlines, it didn’t change the fact that returns on cash deposits won’t necessarily leave people jumping for joy.

Near cash

Near cash basically means anything which can be converted to cash without too much effort.  Possibly the most common example of this would be bonds.  On the one hand, near-cash investments may have low risk of capital loss.  On the other hand, they may struggle to keep pace with inflation.

Equities

Equities are essentially a way of investing in companies.  You can buy shares in individual companies or buy into funds (or a combination of both).  Even if you only look on the UK stock exchange, the sheer number of options for investment can leave you feeling either excited or bewildered.  That even before you get to the international markets.  If you’re not confident of your ability to navigate the stock exchange by yourself, then this is an area where professional advice could be a great help.

Tangible assets

Tangible assets are physical items, from ones which you can hold in your hand (such as precious metals) to real estate (such as property and land).  There are advantages and disadvantages to holding tangible assets and these can be discussed with a financial adviser.  It may be worth remembering that sometimes you can use equities (or bonds) to benefit from an asset class without holding the physical item, for example, investing in property developments rather than buying property.

Diversification and ISAs

One of the few pieces of advice which applies pretty much across the board is that people should make full use of any opportunities to reduce their tax liability.  These days there are several different forms of ISA available and so if you qualify for more than one of them, it may be very helpful to talk to a financial adviser about which particular one is right for you.  In any case, you almost certainly want to make full use of your annual ISA allowance if you possibly can.

The value of your stocks and shares ISA and any income from it may fall as well as rise. You may not get back the amount you originally invested.