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Inadequate diversification

Investing in assets such as equities will generally provide the best returns over the longer term, but your returns only matter when you want to access your capital. These investments will fluctuate in value and those that do so most will (generally) have the greatest potential for return.

Not all investments fluctuate in the same way or indeed in the same direction. Some investments might be rising in value whilst others are falling. We call this ‘negative correlation’. By combining assets that correlate differently, we seek to build diversified portfolios that will maximise returns for a given level of risk.

One of the problems with diversification is that correlations between different assets vary over time. Usually fixed interest bonds represent a source of protection during equity market falls but that’s not always the case.

EQ tip: the overwhelming view of professionals is that broad diversification is a sensible approach.