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For many people, managing risk is an important part of investing. You can do this by spreading your money across different types of investments. This approach is called diversification.
What is diversification?
Put simply, it's when you spread your money across different types of investments to help manage investment risk.
With diversification, you're less reliant on the performance of any one of your investments. So, if one performs poorly, another type of investment you hold could help balance these losses and potentially reduce the impact. This can help make your investments more resilient to market fluctuations and unforeseen events.
Find out more about how it works in our short video.
Transcript
Imagine you’re packing for a trip…
But you’re not sure what the weather will be like.
It might be sunny.
It might rain.
It might get chilly.
So what do you do?
You don’t just pack swimsuits…
And you don’t just bring a thick winter coat either.
You pack a bit of everything.
That’s exactly the idea behind diversification when you’re investing.
Diversification simply means not putting all your money in one place.
Instead of relying on one investment to do all the work,
you spread your money across different types of investments.
That could mean mixing different asset types
(like shares, bonds or property),
spreading investments across different countries and regions,
and not relying too heavily on one sector or industry.
Because markets, like the weather, can be unpredictable.
Some investments do well when times are good.
Others tend to hold up better when things are tougher.
If all your money is in one place,
and that investment struggles,
your whole plan could be affected.
But when your money is spread out,
a dip in one area may be balanced out
by steadier performance somewhere else.
Diversification helps smooth out the ups and downs.
It’s about aiming for a steadier journey —
not avoiding bumps altogether.
It’s important to say:
diversification doesn’t remove risk completely.
Just like a holiday where it rains,
even though you packed for sunshine,
investing always involves some uncertainty.
The value of investments can go down as well as up.
But being diversified means
you’re better prepared for whatever comes along.
You’re not guessing the future —
you’re getting ready for it.
How to diversify your investments?
Spreading your money across different investments is at the core of diversification, but there are several ways you can do this. Here are some of the options.
Across investment types
This involves putting your money into several different types of investments, such as shares (sometimes called 'equities'), bonds (loans to countries and companies), commercial property and specialist areas like commodities (gold, oil or wheat).
What drives these investments to rise or fall in value is very different. For example, what affects the performance of commercial property is likely to differ from what influences stock markets where shares are bought and sold.
Many investment types tend to perform independently of each other in different market conditions and at various points during the economic cycle. In investment speak, that’s called ‘low correlation’ – they don’t share a close relationship and so behave differently.
Across geographies
You can also diversify geographically by investing across different regions, countries and continents. This reduces the reliance on the performance of any single market.
For example, you could choose to invest mainly in UK shares but also include some exposure to European and US company shares.
Across sectors
Similarly, investing across various sectors or industries, such as technology, healthcare or finance, can also help reduce the risk associated with the performance of any single sector.
To diversify your investments even further, you can invest across company sizes too. This involves investing in a mixture of large and small companies (known in the industry as large-cap and small-cap companies, based on each company’s valuation).
Balancing risk with reward
It’s important to understand that diversification can’t eliminate all risks. The value of all investments can go down as well as up, so you must be prepared that you may get back less than you invested.
And there may be times, for example during extreme uncertainty in financial markets, that even seemingly diverse investments perform more similarly than expected. That could see them all fall in value at once.
Diversifying too much can also limit potential gains. Strong performance from one investment may be diluted by weaker performance from others, pulling down your overall return.
All investors must balance how much risk they’re prepared to take in return for potential rewards. Generally speaking, taking more risk gives the potential for higher long-term returns. To better understand how much risk you’re comfortable taking – your attitude to risk – our risk profiler can help.