Diversification versus Asset Allocation

There is a lot of confusion, even amongst financial advisers, about the difference between diversification and asset allocation.

The most important thing in building a portfolio is to have the right asset allocation. This means having as much exposure as possible to the assets which have historically out-performed other investment classes over the long-term. The assets you should be investing in are global shares. The price you pay for this long-term growth is short-term volatility. If you cannot stomach this volatility, then you add other assets to your portfolio which will “dampen volatility” which effectively means stifle long-term returns. For many people this is fine, if it helps them sleep at night. But make no mistake, the default for a long-term investment portfolio should be 100% global equities.

However, people (including many advisers) often think diversification means having lots of other lesser performing asset classes in your portfolio, whether you want them or not. This is why their long-term returns, after charges, barely exceed savings rates. In our opinion, they are confusing asset allocation with diversification. Warren Buffet even refers to it as DIWORSIFICATION!

So, if diversification is NOT asset allocation, what is it? Well, having made the right asset-allocation decision to invest in global shares, diversification means investing in different types of global shares, to minimise the risk of having all your eggs in one basket. Global shares come in many forms. You can have exposure to different countries, different sectors, large or small companies and companies focused on growth or income. Diversification is investing across a broad spectrum of these different types of global equities. The safest way to do this is investing via funds, rather than individual shares. Our equity portfolio is currently invested 100% in global shares, via three, carefully selected funds, which are reviewed all the time.

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