Why diversity can help to spread the investment risk: Sarah Coles
Obviously my first thought on hearing the news was how lucky she was. I’d love to buy the house two doors down from me - it’s much nicer than mine. My second thought was that while she has very good reasons for doing it, she may not have considered all the risks.
To be fair to her, the reasons behind it are perfectly sensible. Her dad has lost his mobility, and can’t get up the steps into his own home. He couldn’t raise enough money by selling his place to buy something more accessible close to her, so she’s done it for him. It’s not an investment, it’s a solution for her family. However, her plan is for him to live there as long as possible, and then, she says “It’ll provide an income for me when I retire.” This is where it becomes an investment, and the logic stops making quite so much sense.
Advertisement
Hide AdAdvertisement
Hide AdWhen investors are buying a property to rent out, plenty of people will look for somewhere nearby. It’s easier to keep an eye on the property, and manage any issues as they arise. They know the area, so feel confident they know the kinds of properties that will do well on their doorstep. However, as investments go, you couldn’t cram any more eggs in the same basket.
Property itself is an incredibly concentrated investment. Most people can’t afford to invest in many, so they have everything pinned on the performance of one or two specific homes. If anything goes wrong with the buildings themselves, or affects the market nearby, they’re completely exposed. In most cases they have a mortgage too, so they’ve borrowed to invest – which magnifies a concentrated risk. By buying close to your property, you’re marrying up the risk of your rental property to the risk of your own home. If there’s a new road, flight path or widespread subsidence, you’ll be hit on both fronts. Even if your area just slips down the desirability scale, and property prices fall more compared to other places, you’ll suffer twice.
Most people understand this kind of concentration would be a highly risky approach if they took it with any other investment. Investors appreciate that life is uncertain, so there’s a risk involved in selecting a fund with a small number of highly focused investments – or opting for a handful of individual shares. They know this will mean more volatile investments, and that if a single company goes bust, it will have a significant impact on you personally.
It's why so many investors buy into funds with broad holdings, which are specifically designed to spread the risk. Your money is pooled with that of all the other investors, and then the manager buys a range of investments – so your investment is diversified from the first pound. Some will pick a broad global fund so they have investments across the world, and some will pick mixed assets funds – so they’re spread across all sorts of assets from shares and bonds to gold.
Advertisement
Hide AdAdvertisement
Hide AdOnce they’ve built up a pot of cash, they’ll then usually look to diversify by buying funds in other sectors, so their fortunes aren’t tied up with a particular kind of company – or the economic position of a specific country.
It’s worth highlighting that once they’ve spread their investments across a number of funds, it’s worth checking they’re as diverse as they think they are. The world economy is dominated by a small number of enormous companies. These make an appearance in an awful lot of fund portfolios, so it can be a useful exercise to check the top ten holdings of the funds you have, so you can appreciate any major crossovers. When I suggested this to a friend, he admitted that he’d had no idea how many of the funds were holding Microsoft. In fact he came back saying “I probably have a majority share in the company.”
Diversity is vital. We did a piece of work measuring how people invest, and the average impact that particular behaviours have on performance. Diversification was one of the things that had the most positive impact on people’s investment performance. Essentially, the more diversification in our client’s portfolios, the better they did on average. And while there are never any guarantees that what has played out on the past will continue to apply today, it makes logical sense not to put all your eggs in the same basket.
Of course, there’s always the exception to the rule. Years ago, I remember talking to someone who had sold her house to go travelling, and decided to use the proceeds to buy gold. I explained that this was a massive concentration of risk, but she wasn’t having a bar of it. So she snapped up gold, headed off on her travels, and then the global financial crisis hit. She made a small fortune.
Advertisement
Hide AdAdvertisement
Hide AdFor my property-buying friend, I hope she’s equally lucky. But personally, I’m not planning to make luck a major cornerstone of my retirement planning. To be honest, I don’t really have much choice given the whole ‘not being able to afford a second property’ issue. Even if I could, the lack of diversity might well keep me up at night.
Wait-and-see savers fail to jump
Half of savers have no plans to switch their savings for a better interest rate, but only around a quarter of this group say they’re staying put because they already have the best possible deal.
For some, the problem is a horrible misunderstanding, because one in ten say they’re waiting for rates to rise further. Unfortunately, this looks distinctly unlikely. The most competitive deals among longer fixed rates were already falling when the Bank of England paused rate rises in September, and now NS&I has withdrawn the one-year deal that was propping up that part of the market, we’re likely to see savings rates gradually drift south from here.
Meanwhile one in six say interest rates are too low to be worth bothering with a switch. This is a crying shame, because there are still some great deals on the market. Plenty of banks are making hay now that some of the most competitive deals have been withdrawn, so you can still get over 6% over one-year fixes and almost 6% on longer-term ones. They’re the kind of rates you’d have given your right arm for over the past decade.
Advertisement
Hide AdAdvertisement
Hide AdFor others, savings inertia has them in a tight grip. One in ten say they probably should make a move, but can’t be bothered, and one in six say it’s too much hassle. If you’re struggling to get round to switching, one option is a cash savings platform. You can open a single account, and then move between different accounts from different banks without having to go through any more paperwork, so it’s easier to overcome inertia and get a better deal.
SARAH COLESHead of Personal Finance and Podcast Host for Switch Your Money OnHeadline Money Expert of the YearHargreaves Lansdown