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Back to Basics: Diversification

Amy Thompson-Cobb, aged 10, asks Morningstar analyst Jon Miller why diversification is so important when investing

Holly Black 31/10/19

Amy Thompson-Cobb: Hello. My name is Amy Thompson-Cobb, and this is Jon Miller. And we today are going to be talking about diversification. What is diversification?

Jonathan Miller: Well, it's a long word, isn't it? So, it's a good question to get to the bottom of. It's about not having all your eggs in one basket. In investing, it's about not just investing in one company, but investing in multiple ones, because over time, they will have different positives and negatives that occur with them. So, you want to have diversification. So, be spread your risk where different things are happening, and you're not just exposed to one company.

Thompson-Cobb: How many companies does the funds usually invest in?

Miller: Well, every fund is different. So, you got to look at what the fund is trying to achieve and how the fund manager is doing things. Some funds can be concentrated. So, I think 30 is probably a minimum you'll see. Some funds can be 100 or so. You then also got another type of funds which aim to deliver the same performance as a stock market. So, what that does is it invests in pretty much all the companies in the stock market to deliver the same performance. So, if you're investing in the UK for, what we call the tracker funds, something that tracks the market, you're looking at about 600 companies in that.

Thompson-Cobb: Why do they invest in so many?

Miller: Well, it comes back to that diversification point. So, where do you – I don't know – where do you go clothes shopping, for example?

Thompson-Cobb: Primark.

Miller: So, Primark. So, if you were to put £20 into Primark, it comes back to the point that if Primark has been doing well, but if something changes in the future, and its performance goes down, you're just there with Primark's results. What you want is to have that diversification, invest in a number of different companies to leave yourself less exposed to one doing really badly.

Thompson-Cobb: So, do you only need to invest in one fund?

Miller: Well, I think you've got to start somewhere. So, you know, if you had a Christmas present and said, right, I want to invest for my future, it probably makes sense, you're only going to start with one. But over time, I think you should be looking for a few different areas, whether it be different geographies in the world, you know, it could be America, it could be Europe, it could be emerging markets, you can invest in all these areas. So, over time, I think you do want to diversify and end up with more than one fund.

Thompson-Cobb: Thank you, Jon. Goodbye.

About Author  Holly Black

Holly Black  

is Senior Editor, Morningstar.co.uk