How Do Funds Diversify My Investments?

Investing in funds can offer a straightforward way to diversify your portfolio across various assets, providing you with exposure to a broad range of investments in a single investment vehicle. Let’s explore how funds can achieve diversification and why it’s beneficial for investors.

Understanding Funds as Diversified Baskets

Funds, whether mutual funds or exchange-traded funds (ETFs), pool money from multiple investors to invest in a diversified portfolio of assets. If you’re not sure what these are, don’t panic, we explain everything in our initial courses on investing! These assets can include:

1. Stocks: Shares of companies across different sectors and regions.
2. Bonds: Debt securities issued by governments or corporations.
3. Property: Real estate investments such as commercial buildings or residential properties.
4. Commodities: Raw materials or agricultural products like gold, oil, or wheat.

Benefits of Diversification through Funds

1. Risk Reduction: By spreading your investments across a wide range of assets within a fund, you can reduce the risk associated with individual stocks or bonds. If one asset underperforms, it’s offset by others performing better, potentially smoothing out your overall returns.
2. Access to Expert Management: Funds are managed by professional fund managers who conduct extensive research and analysis to select the best mix of assets. This expertise can (but doesn’t always) enhance the performance and risk management of your investments.
3. Convenience and Accessibility: Investing in funds allows you to access a diversified portfolio without the need to individually research and purchase multiple securities. This can make it easier for both novice and experienced investors to manage their investments efficiently.

Risks of diversification through funds 

1. There’s no choice: If you want to pick specific stocks or deliberately exclude those that you don’t like, there’s no choice, it’ll be in the fund. 
2. Moral mismatch: In the same way that there is no choice, there could well be a mismatch in the moral compass of investments and strategies in funds. It might be that you wouldn’t imagine oil companies to have a place in sustainable funds, managers might see otherwise. 
3. Costs associated with trades: As the fund manager is buying and selling assets to maintain diversification in the fund, it could be that there are extra costs associated with the fund that were previously unforeseen or not otherwise incurred if you were investing outside of the fund. 

Types of Diversification in Funds

1. Asset Allocation: Funds allocate investments across different asset classes like stocks, bonds, and commodities based on the fund’s objectives and strategy. This diversification can reduce the impact of volatility in any single asset class.
2. Sector and Geographic Diversification: Funds can also diversify across sectors (e.g., technology, healthcare) and geographical regions (e.g., global, emerging markets). This diversification can help to mitigate risks associated with specific industries or economic conditions in particular countries.

Access to a Broad Range of Investments

Investing in a single fund can provide access to tens, hundreds, or even thousands of underlying assets. This diversity allows you to benefit from:

1. Economies of Scale: Funds pool resources from many investors, allowing them to achieve lower transaction costs and potentially better pricing on investments.
2. Market Exposure: Depending on the fund’s strategy, you can gain exposure to markets and investment opportunities that might be challenging to access individually.

Conclusion

Investing in funds can be an effective strategy to diversify your investments across a wide range of assets, reducing risk and enhancing potential returns. By leveraging the expertise of professional fund managers and gaining access to diversified portfolios, you can build a robust investment portfolio that aligns with your financial goals and risk tolerance. Whether you’re a beginner or seasoned investor, funds can provide a convenient and efficient way to achieve diversification and optimise your investment outcomes over time.