What is diversification?

When investing, it is near-impossible to predict what sectors and geographic regions will provide the best return for a given level of risk. As such, a common principle of investing is to diversify, or to hold a wide variety of assets from around the world. Blending assets together like this almost guarantees holding both winners and losers, with the overall performance blended to mitigate the worst performing assets. Good diversification means that, for example, failures like Northern Rock do not have a crippling impact on a portfolio as a whole, thought the wider impact of the credit crunch as a whole would still have been felt by most investors, albeit an impact that would have been reversed for a diversified portfolio in the growth years that followed.

Diversification can refer to either single assets or entire sectors. For example, continuing the example above, a portfolio investing in global equities would likely be more diversified than one focusing only on the UK, which in turn would be more diversified than one focused on UK financial institutions. In particular, there were a number of clients advised to hold very concentrated investments in life settlement funds, private equity or overseas property in the past two decades or so.