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Portfolio diversification

Portfolio diversification is the practice in which an investor spreads their investments across a range of assets or investment vehicles. The approach isn't intended to maximise returns; it is undertaken to try and reduce risk, and limit the impact of volatility. By having a diverse portfolio, investors help protect their money from the risks inherent in many investment vehicles.

At it's simplest, portfolio diversification is essential the old adage 'don't put all your eggs in one basket'. An unexpected economic or geopolitical shock, such as the global pandemic that started in 2020, can quickly change how successful an investment is. If you have all your money in one investment type (such as shares or cryptos for example) then a crash in these markets can leave you out of pocket. Portfolio diversification can help reduce this risk.

Physical gold bullion is one of the best ways to diversify your portfolio, as we discuss below. By transferring just 5% of your money to gold, you can help protect your wealth against the volatility of the current financial system.

Risk diversification

A non-diverse portfolio – one in which all of your money is in one place – will have full exposure to the risks of that particular investment. For example, an investor with a £100,000 portfolio might have chosen to invest their money in a single company’s stocks. If that company were to suffer a shock, resulting in their share value falling, this would negatively impact the investor’s entire portfolio.

Some investors might choose a number of stocks, or put their money into an investment fund that does this for them. This can reduce risk, especially if the stocks are varied between industries and geographical locations, but still carries an overall market risk as many investors will remember during the financial crisis of the late 2000s, and other crashes across history.

Effective risk diversification requires investments made in wholly differing markets; which will respond to different influences. By doing this, if one part of a portfolio underperforms, the others will either maintain values or potentially grow, countering the loss in an ideal situation.

One of the best ways of ensuring a diverse portfolio is to invest in vehicles with negative correlation; some markets will do well when others struggle. Even if not a like-for-like correlation, by having some level of opposing performance, your money will have a degree of protection.

Precious metals, such as gold and silver, are considered excellent ways to diversify a portfolio of any size. Gold especially is considered a hedge against inflation, and inflation is one of the key risks for economy-based investments like stocks or ISAs. Gold is also a safe-haven asset; when other markets crash, gold typically sees its value increase. Read more on why you should buy gold.

One of the difficulties faced by those who diversify only within the stock market is the cost and complication involved. Multiple stocks, across different trading markets, will often involve several brokerage fees, management margins, and more. With physical bullion you simply buy your metal and you're done. You can have it delivered to you or you can have it stored. It's as simple as buying any other product online.

Investors can even diversify between precious metals, buying gold, silver, platinum or palladium. Each market reacts to different influences in different ways, but all are physical assets, making them ideal to diversify against economy driven investment vehicles like stocks, property or savings accounts.

Effect of diversification on portfolio risk

Diversification of portfolios can help to reduce risk, as this chart demonstrates:

Chart showing the performance of gold, versus the performance of the average S&P 500 during the financial crisis.

Gold would not only have protected your investment during the financial crisis, but would also have seen it grow in value significantly. By diversifying your portfolio with gold, your risk would have been reduced, and your returns increased.

If we take Q1 2013 as the end of the financial crisis – the point at which stocks had recouped their losses – here is how three different example £100,000 portfolios, with differing levels of diversification, might have performed.

  • £100,000 in S&P 500 - £0 in Gold: By the end of the financial crisis, the S&P had recovered its losses, and gained a modest 4%. The initial investment would have been worth £104,160 - a very small gain. At its worst however, the investment would have lost £42,580, and no doubt left the investor worrying over their nest-egg.

  • £95,000 in S&P 500 - £5,000 in Gold: By having just 5% of your portfolio in gold, the investment value would have increased to £115,119; the reduced exposure to the financial crisis helping to keep your portfolio growing.

  • £80,000 in S&P 500 - £20,000 in Gold: By diversifying even further, your initial investment would have increased to an impressive £147,996. A near-50% return on investment would have been considered a great success in this time period, and highlights just how strong gold can perform in these times.

By adding gold to your portfolio you can protect your wealth, and potentially help it grow. Portfolio diversification can of course take many different forms, and a health portfolio will include many different types of investments. If you would like to speak to someone about diversifying your portfolio with precious metals, please speak to our support team on 0121 634 8060, who will be happy to assist you. Alternatively, you can email us at support@bullionbypost.co.uk.

Please note: The information above is for research purposes only. We strongly recommend investors seek independent financial advice before making any decisions regarding their money.

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