Investment Volatility and the Benefits of Diversification

It is important to understand that investing money in stocks, shares and bonds can mean that the value of your investment can go down. At some point during your investment journey, the value of your investment will be worth less than it was the day, week, month or even years before.

What is important to remember that we are not trying to help you beat an investment market or a particular benchmark but rather help you to achieve an investment objective, so providing you remain on track to achieve your objectives, the investment part is merely the engine behind the plan.

To make the point, the chart below shows how Global equities, UK equities and Global investment bonds performed between June 2007 and April 2009.

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During this period, Global and UK equities were down by over 30% whereas Global bonds were up by almost 50%.

By blending different asset classes, known as diversification, we can mitigate some of the market falls.

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The following chart is a blend of the Global Equities index, the UK Equities index and the Global Bond index, split equally between Equities and Bonds.

By blending the different asset classes we mitigate the falls of the equity markets.

You might argue, “why can’t we just invest in equities when equites are doing well? and bonds when equities are not doing so well?” The answer is nobody can predict investment markets. You need to make two decisions at exactly the right time, when to buy and when to sell. The chances of getting one right is low, the chances of getting both decisions exactly right is extremely remote which is why I advocate a diversified long term investment strategy.

Immediately after this period, those same asset classes performed as follows:

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Hopefully, this highlights that had the advice been to sell equities in early 2009 and not gone back in at the right time; you could have missed out on returns in excess of 60%.

The focus therefore should be on your objectives, do not worry about the journey, worry about the destination and that is part of what I do during our annual review process. Long term investment returns generally trend upwards, making extreme scenarios such as above, look almost insignificant although they most definitely will not feel like it at the time.

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Below is the same chart, but without the noise.

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