Here’s why diversification really is an investor's best friend

WE all know we should be diversified in our investments - but we probably all get frustrated at the downsides of diversification too.

Who hasn’t looked at their portfolio and wished that every holding could match their best performers, instead of the mixture of wins and losses that diversification inevitably results in.

It is this frustration that can so often lead to rash decisions and taking on too much risk. So it’s important to be reminded every so often of why diversification is so valuable, and how it can lead to more dependable returns in the long run.

We recently conducted some analysis to explore the benefits of diversification. It was a simple exercise - examining the returns from a number of individual asset classes over various time periods and comparing those to the returns from a diversified pot consisting of all those asset classes.

Exercises like this always come with caveats. The returns were specific to the time periods in question - there’s nothing to suggest they will be repeated in the future. However, the results show how a diversified pot has been consistently among the better performers over 5, 15 and 20 years.

The chart below shows the total achieved by investing £15,000 in each of the different asset classes - comprising of shares from different stock markets, bonds of various types and alternative assets like commodities, cash and real estate. These were compared to the total achieved by investing £1,000 in each of the 15 assets within a diversified portfolio.

The chart shows what happened over the past 20 years, with the diversified pot rising to £74,634.61 - shown by the red line. That meant only 6 of the 15 individual assets performed better over that time period. The results were even better over 5 years - where the diversified pot was beaten by only 4 assets - and 15 years - where 5 assets produced a better return.

Asset class performance over the past 20 years

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only.  This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.