Diversification is defined as the practice of spreading investments to ensure that an investor’s exposure to a single asset class is limited. This aim of diversification is to help reduce an investment portfolio’s volatility over time. Most diversified portfolios are based on three key components.
Domestic stocks
Representing the more aggressive part of a portfolio, stocks offer opportunities for greater growth over time. However, they also come with a greater risk, especially in the short term. As stocks are the most volatile asset class, an investment in a specific stock can be have less value when or if an investor opts to sell it.
International stocks
Stocks provided by non-UK companies sometimes perform differently than their British counterparts, offering exposure to new opportunities. Like domestic stocks, foreign stocks have the potential for higher returns, but carry higher risk.
Bonds
Bonds can provide regular income via interest and are considered less volatile compared to stocks. They are often used in portfolios to cushion unpredictable stock market fluctuations as they behave differently from stocks. Safety-focused investors often load portfolios with government and high-quality to reduce exposure to stocks. However, such investors must accept lower long-term returns from many bonds. High-yield bonds offer greater returns but come with more risk.
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