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Diversification is a crucial way to help safeguard your investments should your portfolio come across hard times outside of your control – such as a stock market crash. If you’re looking to smooth out the “potholes” along your investment journey and reduce unnecessary risk through over-exposure to one market, company or market, then diversification can help.
In this short guide, our investment team here at Bure Valley Group offers five tips to help successful investors with their thinking – regarding their diversification balance. As a firm with a specific focus on startups and tax-efficient equity investments, we will concentrate our thoughts here on stock diversification. We hope you find this content useful. To find out more about our own EIS and other investment opportunities, visit our portfolio page here. To enquire about our latest projects and funding, you can reach us via:
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#1 Include different company stages/types
A diversified portfolio will not only include startups, medium-sized businesses and large-caps. Rather, it will typically incorporate a blend of these which will depend on the individual investor. For instance, a younger, entrepreneurial investor with a higher tolerance for risk may be more willing to include a higher percentage of startups within his/her portfolio (which tend to be higher in risk as well as potential reward). An older investor who is nearing retirement, however, may wish to include more “tried and tested” companies such as publicly-list large companies, which are less likely to fail and thus erode the value of their nest egg.
#2 Include different industries/sectors
If there’s one crucial lesson which investors have learned from the market fallout caused by COVID-19 and the lockdowns in 2020, it’s the importance of diversifying across industries and sectors to reduce risk exposure within any single one of them. In the first quarter of 2020, for instance, many investors were hit particularly hard if they had large equity portfolios which concentrated on sectors such as aviation, hospitality, entertainment (e.g. cinemas) and restaurants. Those investors which had spread themselves out more evenly to include less badly hit sectors/industries such as online retail, supermarkets and online solutions (e.g. video conferencing software) would likely have fared better.
#3 Diversify using asset types
Of course, many angel investors like to concentrate their efforts on producing a return from startups using ownerships and capital gains. In short, you invest in an early-stage business in exchange for owning a piece of it, which you hope will rise in value so you can take a higher level of profit or capital gain (from a sale) later. Yet there are other great ways to extract value from your equity investments which can help to diversify your portfolio. Company bonds, for instance, can be a good way to generate an income from more mature companies. These are usually lower in risk compared to dividend investing, since a business – if it fails – is obliged to focus on compensating its lenders before turning its attention to shareholders.
#4 Include individual company investment and funds
Every investor is different. Some will like to focus on building their portfolio by picking each of their company investments individually. Others might be willing to delegate this stock-picking responsibility to professional investment managers via funds. One possible way to diversify your portfolio – regardless of which side you lean towards – is to consider including a mixture of funds and individual equity investments. The latter, for instance, might focus on industries or sectors which you are familiar with – allowing you to bring more investment knowledge to the vetting process as you consider which options to include in your portfolio. Many investors might find it helpful to find a specialist fund manager to help them find the best opportunities in other areas where they might have less expertise or experience.
#5 Look at home and overseas
It is a well-known fact that most investors have a “domestic bias” when it comes to choosing companies to include in their portfolios. A U.S.-based investor will typically prioritise businesses in the U.S. because they “feel safer” or “better”, whilst a Japanese investor will also often lean towards equity opportunities in their own domestic market. This, sadly, often produces at least two negative outcomes – i.e. over-exposure to one’s own home market, and missed investment opportunities which could have been seized had the investor been willing to also look abroad.
On the former, for instance, it’s important to note that focusing your equities solely in the UK, U.S or other home country leaves your equities to the mercy of that particular economy. If the UK suffers disproportionately due to a shock (e.g. a no-deal Brexit?) then a UK-focused investor may see their portfolio suffer more than an investor who also has U.S., Japanese and European equities under their belt. Moreover, there are often investment opportunities abroad which are not available at home. Japanese markets have a strong reputation in robotics and other cutting-edge technologies, for instance, whilst the UK and Israel are currently developing a knack for cybersecurity. It is a shame to miss out on opportunities like these due to “home bias”, and including overseas equities can be a helpful way to diversify further.
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