Diversification and asset allocation may not fully protect you from market risk.
As investors, we know we shouldn’t put all of our eggs in one basket. Investing in just one company can be very risky, which is one reason that many investors choose ETFs tracking indices such as the MSCI World or S&P 500 to diversify across hundreds or even thousands of stocks.
However, to create a truly diversified portfolio, investors should also look to other asset classes, such as bonds. Bonds can help to counterbalance fluctuations in stock prices and may help preserve your savings while potentially providing more income than daily allowance.
The mix of stocks and bonds in your portfolio can have a big impact on long-term returns. Stocks may deliver higher returns, but tend to be riskier. Investors wanting a more conservative, lower-risk approach may therefore allocate more to bonds, and vice versa. One way to decide the right mix is to start with your time horizon: the longer you plan to keep your money invested, the more risk you may be willing to take.
Two main risks related to fixed income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to repay the principal and make interest payments.
Diversification is also key when deciding which stock and bond ETFs to invest in. For example, investing in an S&P 500 ETF alongside one ETF that tracks the world’s biggest tech companies might feel like diversifying, but there’s likely to be significant overlap, with many companies featuring in both. Similarly, buying a German government bond ETF alongside one tracking German corporate bonds could mean your portfolio is overly exposed to the health of the German economy, for example.
After building your portfolio, it’s important to monitor its progress and ‘rebalance’ it periodically. Imagine you start with 50% in stocks and 50% in bonds. If the stocks rise in value and the bonds fall, this ratio will change, and your portfolio may become riskier than you intended. You’d need to reduce your stock ETF holdings and increase your bond ETF holdings to ‘rebalance’ it back to 50:50.
If this all sounds stressful and time consuming, don’t worry – there’s another way! iShares Portfolio ETFs each comprise 15-25 ETFs, giving you exposure to over 8,000 individual stocks and bonds across a wide range of companies and governments, to create a truly diversified portfolio. They’re designed to help you manage risk while growing your savings, and can take the hard work out of building and maintaining a diversified portfolio – all you need to do is pick the one that fits your goals, time horizon and risk appetite.
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