Asset Allocation Portfolio diversification: A guide to growing your investment garden

A well-diversified portfolio is like a thriving garden – carefully cultivated, resilient through seasons, and designed to grow steadily over time. In today’s dynamic investment landscape, portfolio diversification remains a cornerstone to managing investment risk and building long-term wealth.

This article walks you through:

• Why diversification matters
  • Diversification helps reduce risk and smooth out returns
• How to diversify your portfolio
  • Spreading investments across asset classes, regions, and sectors
• Common pitfalls to avoid
  • Tendencies to go "all-in" or over-diversifying your portfolio

For technical terms, please refer to our Glossary

Why diversification matters

Diversification is often called “the only free lunch in investing”, a quote attributed to US Economist Harry Markowitz, the father of Modern Portfolio Theory. He demonstrated that diversification challenges the notion that higher returns mean higher risk.

By combining different types of investments that don’t all move in the same direction at the same time (assets with negative or low correlation), you can reduce overall risk without necessarily sacrificing returns.

1. Risk management

A well-diversified portfolio can help to mitigate risk in the following ways:

· Reduce unsystematic risk

Unsystematic risk, or diversifiable risk, is specific to individual companies or sectors. For example, a company might struggle due to poor leadership or changing consumer trends, while a sector could be affected by new regulations or shifts in economic cycles. Unsystematic risk can be reduced by investing in a broad range of companies across different sectors. When one company or sector underperforms, others can potentially balance the impact.

· Manage systematic risk

Systematic risk, also known as market risk, can be driven by inflation, recessions, and interest rate changes. While systematic risk cannot be eliminated, it can be managed by diversifying across asset classes that react differently to the macroeconomic environment, such as stocks and bonds. Some investors use hedging strategies, which means investing in assets that typically move in the opposite direction of the market.

3. Broader opportunity set

Best and worst performers keep on rotating

Calendar-year total returns of select asset classes (%)

As the above chart illustrates, asset classes go in and out of favour. Portfolio diversification not only manages risk but broadens your opportunity set. Furthermore, market leadership has historically rotated across countries, sectors, and asset classes. The 1980s saw Japan’s rise, followed by the tech boom in the 1990s and China’s rapid growth in the 2000s. By diversifying, investors could benefit from a wider range of potential growth drivers wherever they arise.

How to diversify your portfolio

Diversification can be achieved in many ways, including across asset classes, sectors, geographies, market capitalisation, currency, and investment styles. In this article, we outline three methods of diversification:

1. Diversifying across asset classes

Diversification often begins with asset allocation. Determining the right mix requires assessing one’s investment goals, time horizon, and risk appetite. In theory, stocks can offer higher growth potential but tend to be more volatile, while bonds tend to offer stability and income.

Types of asset classes can include equities (stocks) for long-term growth and capital appreciation, fixed income (bonds) for steady income and portfolio stability, cash for liquidity and potential capital preservation, to alternative investments or real estate that can act as a hedge against inflation. These are summarised in the image below:

Diversification is at the heart of multi-asset portfolios, a fuss-free way to be diversified without the hassle of managing it all yourself. A 60/40 portfolio (60% stocks and 40% bonds) is a classic approach to balanced investing, while a 70/30 portfolio (70% stocks and 30% bonds) may suit investors with a bigger risk appetite.

2. Diversifying within asset classes

A garden flourishes with a mix of trees, shrubs, and grass, but it’s the variety within each group that truly brings out its strength and beauty. In the same way, once you’ve set your asset mix, diversifying within each asset class is essential for building a more resilient portfolio.

· Diversifying across geographies

Regional equities have taken turns to lead

Index returns (%), 1 January 2020 to 30 June 2025

Diversifying across geographies means spreading your investments across different regions. This reduces your overall exposure to localised risks such as geopolitical events, economic downturns, and currency fluctuations. A globally diversified investment approach can also open the door to a wider range of opportunities, whether within equities or fixed income. While certain markets may lead at different points in time, long-term investors can benefit from structural changes in the global economy.

Similarly, global diversification within fixed income can help your portfolio adapt to changing market conditions while taking advantage of low or even negative correlations between markets. This can enhance portfolio resilience and improve the potential for more consistent returns over time.

· Diversify across equity sectors

Returns on individual sectors have varied over the years

Investing across sectors is another way to add depth to your portfolio. The Global Industry Classification Standard (GICS) breaks down the market into 11 sectors, helping investors observe trends and identify opportunities across different parts of the economy. Each sector has its own characteristics and tends to respond differently to changes in the macroeconomic environment.

For instance, Health Care is often seen as a “defensive” sector that provides stability during economic downturns. On the other hand, Consumer Discretionary stocks are considered “cyclical”, typically performing well during periods of economic expansion but facing pressure when growth slows. As the chart above shows, different sectors take turns leading the market, highlighting the value of diversifying across sectors rather than relying too heavily on any single one.

· Diversifying across bond sectors

Similarly, within the fixed income universe, different types of bonds respond differently to economic shifts, interest rate changes, and credit cycles. For example, sovereign bonds tend to perform well during recessions due to their typically lower risk and liquidity, while high-yield and emerging market bonds often thrive in strong economic environments, offering higher returns but with higher risks. By diversifying across fixed income sectors, investors can balance out the unique risks each one carries.

Common pitfalls to avoid

While the benefits of portfolio diversification are clear, investors may still fall into traps in practice, which may play out in the following ways:

1. Going “all in” to one basket

Overconfidence in any one area can lead to concentrated, speculative calls – for example, going “all in” on a single tech stock or a single asset class. This behaviour is often driven by overconfidence bias, which can cause some investors to trade excessively, underestimate risks, and overrate their ability to predict market movements.

2. Spreading too thin (or ‘diworsification’)

On the flipside, some investors may try to cover every possible angle – different asset classes, sectors, regions, and even currencies. While this may feel safe, marginal benefits of diversification can diminish after a certain point¹. Furthermore, an overly complex portfolio can be difficult to manage, requiring time, effort, and expertise to monitor and rebalance regularly.

Finding a middle ground

Finding the sweet spot between too little and too much diversification isn’t always easy. On top of that, regularly rebalancing your portfolio to stay aligned with your investment goals can be time-consuming and complex. Actively managed investment funds can offer a practical solution in today’s complex investment landscape. It’s like hiring a horticulturist to care for your garden: you won’t need to check for weeds every day, and you’ll enjoy greater peace of mind knowing your investments are being professionally tended to.