Coronavirus headlines have recently infected global share markets. Analysts debate and discuss what the economic effects of the viral outbreak will likely be. But you and I can agree on the shared anxiety it has created over the past few weeks.
What would you rate as one of the most reliable safeguards against such stomach-churning market volatility? I’d say diversification, among asset classes, within your share portfolio, and geographically.
What is your risk tolerance?
In investing, risk and return go together; where there is a potential return, there is also a potential loss. For example, since the end of the financial crisis of 2008, most technology and other growth shares had been darlings among investors. There seemed to have been no limit to how much some of these stocks could appreciate. However, the past few weeks have also shown investors how far and how fast they can fall.
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On the other hand, a savings account at a UK-regulated bank or building society guarantees the safety of your money for up to £85,000 per person, yet offers a very low annual return.
Asset allocation – which can simply be defined as how you’d divide your investments among shares, bonds, bank-deposits, as well as other types of investment vehicles such as real estate or physical gold – determines your portfolio risk and returns. The aim is to strike the right balance between more potentially volatile assets such as shares and more stable ones.
Diversifying your stock portfolio
Once you have decided how much of your wealth you would like to have in equities, it is time to look at how you want to allocate your money among different types of shares.
How many stocks should you have in your equity portfolio? The answer would partly depend on the amount available to invest and how much time you can spare to follow your shares. If you are not a seasoned investor, it might be better to start small. You can always increase the number of shares you hold if the company performs well in the long run.
Diversification will not eliminate all the risk in your equity portfolio. But your long-term risk/return ratio is likely to be more attractive. A share portfolio constructed of different kinds of companies and sectors will, on average, yield higher returns and enable you to ride out the volatility of the stock market.
If you are unsure where to begin, a low-cost FTSE 100 or FTSE 250 tracker fund might be appropriate. Or you could invest in low-cost exchange-traded funds (ETFs) such as the iShares UK Dividend UCITS ETF.
Geographic diversification
Many analysts agree on the benefits of international diversification for retail investors. Global markets don’t always move in tandem. So international exposure may help decrease the potential short-term adverse effects of the home bias in domestically uncertain times.
For those investors who may feel overwhelmed by the effect of various domestic issues in the short run, I think an exchange-traded fund (ETF) to consider could be the FTSE All-World ETF, tracking the performance of a large number of stocks worldwide.
At The Motley Fool, we believe in saving and investing for the long term. Having a disciplined focus as well as a diversified portfolio could help investors to get through the ebbs and flows of the market.
