The practice of diversifying investment portfolios is almost as old as investing itself.  Not placing all of your financial eggs in one basket is diversification in a nutshell. It makes perfect, logical sense: spreading your money over numerous equities or securities, spreads the risk. If certain investments do not perform well, only a percentage of your money (as opposed to all of it) is invested in the poorly performing investment.

Many first-time investors take this to mean they should not invest in a single stock or even a few different stocks, but rather invest in a catalogue of stocks within a single market. While this is, by definition, diversification, it does not reduce the risk as much as one would hope. The investor is still exposed to centralised risk.

There is strong evidence illustrating that within an economy, economic phenomena move in unison[1]. In consequence, when the economy as a whole is performing poorly, most individual stocks mirror this downturn. Therefore, if a range of stocks is held within a single market, the level of diversification does not offer the increased protection it should. Even where assets are spread over a range of different equities within a single market, they will all likely follow a similar pattern. The single market bias will reduce the effectiveness of a portfolio as, in real terms, there will be a lack of effective diversification.

In order to fully reap the benefits that diversification sows, investors must move their attention globally; diversifying not through simply investing in a range of stocks, but by investing in a range of different markets.

There are two primary reasons for this. Firstly, as already stated, each market tends to fluctuate as a collective, meaning the investor loses the benefits of diversification if only investing within one market. Secondly, there is no consistently ‘best performing’ market[2]. It is difficult, if not impossible, to predict which market will offer the best investment experience. To experience the greatest chance of strong returns, investors should invest across global markets.

To demonstrate the necessity of global investment strategies, it is worth analogising with everyday affairs. Supermarket shopping, to be specific. Consider a person who only ever shops in one supermarket. Even though they likely buy a variety of products, they are subject to whatever the supermarket imposes upon them. For example, if the supermarket increases all prices by 10%, the customer’s money does not buy them as much. As the customer does not ‘shop around’, they miss out on better deals elsewhere.

Now let’s consider the customer who shops in a number of different supermarkets. If only one supermarket increases its prices, the financial impact on the customer is far less. As their purchases are spread across a number of supermarkets, the effect of any price increase is lessened.

The same is true with global investing. A downturn in a single market will have a lesser impact on an investor with a globally-diversified portfolio as only a certain percentage of the portfolio would decrease in value. In addition to reducing risk in this way, spreading investment across a number of markets will bring the added advantage of reaping the benefits of any market with increasing returns.

It is almost impossible to predict the best performing market, or indeed supermarket, year on year. By investing globally, an investor increases their chance of positive returns while simultaneously spreading the risks. As such, my overarching message is this: invest in a variety of global markets, and shop between a variety of supermarkets.

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[1] H Levy & M Sarnat “International Diversification of Investment Portfolios” 1970 60(4) American Economic Review 668, 668

[2] Dimensional Matrix Book, p64

Daniel McIntosh
Graduate Intern – WealthFlow
daniel.mcintosh@wealthflow.com

This article is distributed for educational purposes and should not be considered investment advice or an offer of any product for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable but is not guaranteed. Past performance is not indicative of future results and no representation is made that the stated results will be replicated. Errors and omissions excepted.

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WealthFlow Group Ltd. Registered in Scotland No SC635011. Registered Office: 10 Charlotte Square, Edinburgh EH2 4DR.

Head Office & Consulting Rooms: 10 Charlotte Square, Edinburgh EH2 4DR.

Mail correspondence to our Central Scotland Admin Hub: WealthFlow Group Limited, PO Box 14947, Grangemouth FK3 3AU.

WealthFlow Group Ltd is authorised and regulated by the Financial Conduct Authority.

The guidance/advice contained in this website is subject to the UK regulatory regime and is therefore restricted to consumers based in the UK.

For your protection, unresolved complaints can be referred to the Financial Ombudsman Service.

To contact the Financial Ombudsman Service, please visit www.financial-ombudsman.org.uk.

WealthFlow Group Ltd. Registered in Scotland No SC635011. Registered Office: 10 Charlotte Square, Edinburgh EH2 4DR.