All investing carries an element of risk. That risk is greater when you are relying on a single source of investment growth, say equity in a single company; if anything were to happen to that company your entire investment portfolio would be impacted.
A key concept of managing risk in a portfolio is that of diversification, which is the spreading of risk across a portfolio to minimise the impact of any single factor.
Diversification can be achieved in a portfolio in a variety of ways and at different levels.
Asset classes naturally behave in different ways, so investing across asset classes is a good way to introduce diversification to your investments. Bonds, equities, cash and property all have different attributes and characteristics, so a mix of these assets is a good place to start, whether this is investing directly or via a collective investment such as an investment fund.
Likewise, investing across different sectors, provides another level of diversification; companies in different parts of the market will react differently to market factors, likewise different types of bond sectors will have different characteristics. A pharmaceutical company, for example, will behave very differently to a bank or construction company. Investing across sectors means that an industry specific impact will not affect more than an element of your portfolio.
Spreading your investment over a variety of geographical regions also spreads your risk. Having a high proportion of your investment in one country means that any geo-political factors affecting that country, such as trade wars or surprise election results for example, could impact your overall portfolio.
If you do have investments in the same asset class or sector, then you should consider whether the investments are correlated. Correlation is a measure of the similarity in behaviour of two securities; if there is zero or negative correlation, then the two investments will behave differently and provide diversification even in the same asset class or sector.
No one can predict the future with any certainty, so providing diversification to your portfolio enables it to perform, and hopefully thrive, in different market environments by managing risk.
How can I see the diversification in my portfolio?
For individual holdings in investment funds, you can view the factsheet provided by the fund manager. For a more widely invested portfolio, your adviser will be able to provide details of the breakdown of assets in your investment.