Now you understand diversification, let's start looking at what you need to do.
Get the Basics Right and Build from There
Let’s never forget that building wealth isn’t rocket science. What I love about people like JL Collins and Mr Money Mustache, the Choose FI guys, and The Escape Artist here in the UK is that they repeat that no matter how wealthy you get (except for the mega-wealthy folks) the principles of personal finance don’t really change.
My three steps – spend less than you earn, insure against disaster and invest wisely – still apply to the person with a net worth of five million pounds as to someone with a net worth of five pounds. The application may be slightly different, but the principles don’t change. Likewise, when it comes to diversification, it’s essential to get the basics right:
1. Most people are well-served with just two accounts – a pension and an ISA
There are very few reasons to have more than one of each account in my view. If you stick with a big-name provider, there shouldn’t be any problem with that provider going bust. And even if they do, remember your money is ring-fenced under the client assets rules. But if you’re worried, stay below the FSCS limit.
2. Most people don’t need more than one or maybe two funds in their accounts
If you use a multi-asset fund like I suggest you do, then you’re getting asset diversification within the fund. Funds like Vanguard LifeStrategy, 7IM AAP, Close Tactical Select and Fidelity Multi-Asset Allocator ranges will hold hundreds if not thousands of underlying stocks and across at least two major asset classes, sometime many more.
None of those are recommendations, by the way – just examples. Once you understand and apply the two points above – that most people just need one pension and one ISA, and just one or two multi-asset funds within those accounts – you’ve got the basics and you can build from there.
You’re doing quite a lot of diversification just with those two, because pensions and ISAs are in completely different tax regimes. You can, of course, access your ISA tax-free at any time. You get tax relief with your pension so it will grow quicker, but you’re taxed if you take money out and you can’t access them before age 55 (or age 57 after 2028).
Only Add Things to Your Portfolio if There is Clear Benefit to Doing so
What might those benefits be? Perhaps you might benefit from different approaches to investing by using different funds. You’ll need to dig a bit here to find out the information you might need, but here’s an example:
Most of my readers and listeners understand how the Vanguard LifeStrategy funds work. They are fixed-allocation, daily rebalanced funds, invested across the globe. There’s no active input at all, hence the very low cost.
7IM’s AAP range is also multi-asset and is also passive just like the Vanguard funds, but the managers aim to add some value by tilting the allocation of the portfolio. That’s what AAP stands for – Actively Allocated Passives. There are also some different asset classes included there that don’t feature in the LifeStrategy range, and so blending the two could be constructive diversification.
Close’s Tactical Select range is multi-asset and it’s passive, but here the managers apply some so-called smart-beta input. So, while they may base part of their allocation on the FTSE250 index, they may look to tilt that in favour of out-of-favour stocks. As this is done largely on a quant basis, this can be done by algorithm, which keeps the cost down.
These are three different approaches to passive multi-asset investing. They’re coming at the same problem from three different angles, and each will likely add value in different market conditions.
NB: adding satellite holdings isn’t really diversification. I don’t believe that anybody needs to add satellite holdings, they do so because they want to experiment with investments without betting the farm doing so, that’s all.
Let's keep going!
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