Diversification Index trackers

NewKidOnTheBlock_2

I hear the word "diversification" all over the place since reading about investment. It's advised to spread your investments across several companies but I wanted to ask if something like a FTSE 100 tracker or FTSE All Share are considered as 1 fund or is this seen as diversifying? After all your money is being invested in many companies that are in the index.

Is diversification meant for people who are investing in single companies? But this wouldn't really apply to someone investing in an index tracker?

noggin1980

NewKidOnTheBlock wrote: »

I hear the word "diversification" all over the place since reading about investment. It's advised to spread your investments across several companies but I wanted to ask if something like a FTSE 100 tracker or FTSE All Share are considered as 1 fund or is this seen as diversifying? After all your money is being invested in many companies that are in the index.

Is diversification meant for people who are investing in single companies? But this wouldn't really apply to someone investing in an index tracker?

1 company = no diversification

a bunch of individual shares = a little bit of diversification.

1 fund (that focuses on 1 country) alot more diversification but still less than is sensible.

a group of funds that gives you world wide exposure (or 1 fund of funds that does this) now you have a good amount of share diversification but thats still likely not enough especially as you get older.

a group of funds that provide world wide share exposure, + some bond funds, + a property fund, + a high interest account with some cash in, now you are well diversified (though its still possible to go further)

being diversified reduces your risk though it likely will reduce potential reward too. for instance 1 share could go up 500% or the company could go bust over a couple of years. If you are invested in thousands of companies (through funds) then your up and downside is more like to be 40% over a year at most and most of the time much much less than that.

ermine

NewKidOnTheBlock wrote: »

I hear the word "diversification" all over the place since reading about investment. It's advised to spread your investments across several companies but I wanted to ask if something like a FTSE 100 tracker or FTSE All Share are considered as 1 fund or is this seen as diversifying? After all your money is being invested in many companies that are in the index.

Diversification means splitting your risk, so think about all the risks you can have, and try and avoid a single point of failure.

Take £200k held a FTSE100 tracker from Vanguard held with Hargreaves Lansdown. What on earth could go wrong?

The obvious - HL could go bust, or have a Nick Leeson that runs off with all the money. There's Government protection for up to £50k in that case, so your potential loss is 150k. Solution - use more than one ISA provider. This is a right pain so to some extent you make a judgement call as to how likely that is.

Vanguard could go bust or employ criminals. Solution - use a bit of Vanguard and a bit of say L&G for your index funds

What else

The FTSE100 could experience a long run of bad performance, compared with what else you could buy. F'rinstance you could buy a world cap-weighted index fund - then if India or Africa does well over the next 20 years compared to the UK you'd get some of that.

Then there's asset class diversification - people often say you should move to having more in bonds as you get closer to retirement.

What about size? Small companies doe better earlier i nthe business cycle and have more potential, though they are more fragile. The FTSE100 by definition is full of big fish, not small fry

http://monevator.com/portfolio-diversification/

and

http://monevator.com/investing-for-beginners-risk-returns-time-and-diversification/

are longer-form explanations of that

Certainly a FTSE100 index fund would be considered more diverse than a holding of five shares, but it's not particularly well-diversified across size, geography or asset class

Radiantsoul

Generally the idea in finance is that people dislike uncertainty, especially if the uncertainty in investments is correlated with their other income.

So when the sun shines it is good news for sunglasses makers, bad news for umbrella makers. If you wanted a smoother investment profile you might prefer to own shares in sunglasses makers and umbrella makers, thus having both basis covered. You may not do quite as well if you had invested in sunglasses and their was a heatwave, but there you go. Of course if staying inside suddenly becomes the new thing you might not be diversified enough.

The FTSE100 represents only about 9% of the worlds total stock makets and at $1.9trillion less than 1% of total wealth. So you could diversify more by holding other geographies, but the stock exchanges of the world are not as dissimiliar as sunglasses and umbrella makers.

dunstonh

I wanted to ask if something like a FTSE 100 tracker or FTSE All Share are considered as 1 fund or is this seen as diversifying?

That is diversifying but its not enough.

20 different company shares is better than 1 share. However, 20 all in say financial is poor diversification. Yes it is diversified compared to 1 but not in the area you invest in.

Getting a UK equity fund diversifies holdings across a number of UK equities. However, you remain focused on UK equity. No US, Japan, Asia etc. So, 100% into UK equity would be considered poor diversification.

You also have asset class. Cash, bonds (uk and global as well as gilts), property and shares. So, you should diversify across them.

Bottom line is that diversification is across type of asset as well as number of assets.

NewKidOnTheBlock_2

dunstonh wrote: »

That is diversifying but its not enough.

20 different company shares is better than 1 share. However, 20 all in say financial is poor diversification. Yes it is diversified compared to 1 but not in the area you invest in.

Getting a UK equity fund diversifies holdings across a number of UK equities. However, you remain focused on UK equity. No US, Japan, Asia etc. So, 100% into UK equity would be considered poor diversification.

You also have asset class. Cash, bonds (uk and global as well as gilts), property and shares. So, you should diversify across them.

Bottom line is that diversification is across type of asset as well as number of assets.

Are there trackers for US, Asia, Japan markets? Also don't you have to pay a lot of money in exchange fees and stuff for investing in overseas companies?

noggin1980

NewKidOnTheBlock wrote: »

Are there trackers for US, Asia, Japan markets? Also don't you have to pay a lot of money in exchange fees and stuff for investing in overseas companies?

yes to question one, no to question two,

There are trackers for the entire world, there are trackers for the entire developed world, there are trackers for the entire developed world excluding Uk, there are trackers for most major countries, there are trackers for continents, there are trackers for individual markets in major countries, there are trackers for small companies, there are trackers for market sectors like biotech, there are trackers for a lot of things.

There are also trackers made up of other trackers so you get an entire portfolio with one product, like the Vanguard Lifestrategy funds.

When investing in the US for example you still buy a fund from a company and invest in pounds and your money goes up and down in pounds. well this is the common scenario anyway.

bowlhead99

NewKidOnTheBlock wrote: »

Are there trackers for US, Asia, Japan markets? Also don't you have to pay a lot of money in exchange fees and stuff for investing in overseas companies?

Yes there are trackers for all markets. You can generally buy them priced inGBP from UK or European based investment managers on the same platforms as the UK FTSE trackers. You don't need to specialty buy foreign currency to invest in them.

If fx rates change you simply see a different GBP price, even if the index value didn't change. The FTSE world index or Japan index or Europe-ex-uk index is available on the same platforms and often from the same fund managers as the UK 100 and 250 and all-share and small cap index funds

EdSwippet

ermine wrote: »

...The obvious - HL could go bust, or have a Nick Leeson that runs off with all the money. There's Government protection for up to £50k in that case, so your potential loss is 150k. Solution - use more than one ISA provider.

The Nick Leeson scenario is much less likely than the platform going bust. If it does your investments are protected because they are 'parked' on the platform but not owned by it.

More here.