Without the benefit of a crystal ball we cannot hope to know which investments will perform best over the next two or three years. And with stock markets around the world highly volatile to say the least, diversification- or ‘spreading your bets’- should be part of every investor’s strategy.

It has been suggested that 90% or more of investment returns are derived from asset allocation, which is arguably the most important concept in investment. This simply means spreading your money across a broad range of investments. With your equity funds for example, it means investing across a range of sectors and countries, so that if one particular area or sector falls, it doesn't decimate your whole portfolio.

But asset allocation requires that you look beyond just equities to asset classes that are not correlated to the stock market - that is, when one falls, the other, in theory at least, rises and vice versa.

The idea is that you suffer fewer losses than if you keep your money in just one area, so that you're generating profits while limiting the downside. So, for example, when corporate bonds are doing well, but shares are falling you don’t sell all your shares and pile into bonds, you just maintain a sensible spread.

The different asset classes you choose to invest in must take account of a number of factors. These must include your specific needs, the length of time until your retirement and perhaps most important of your entire attitude to risk. Having said this, what might a well-diversified portfolio look like?

Apart from cash on deposit for a rainy day which is an absolute must, a diversified portfolio could include index-linked National Savings certificates, funds investing in equities (in different sectors with a wide geographical spread), corporate and government bonds, managed Hedge Funds, commodities including gold and perhaps even property although this asset class is currently in the doldrums.

As a way of achieving diversification from the stock market, investing in commodities is particularly effective, as the two asset classes are almost entirely uncorrelated. Many pundits recommend a holding of gold with prices soaring in 2008 to its highest levels since 1980. The natural resources sector (oil, gas etc) is riding a wave of demand from the emerging economies such asChina and India. This has helped funds such as the JP Morgan Natural Resources produce massive returns of late. But beware! This sector is highly volatile. Gold and oil are diversified but they can be highly speculative, so they should make up only very small portion of your portfolio.

And having diversified your portfolio and invested in a range of un-correlated funds it is absolutely crucial that you continue to monitor performance. Which is why you should take a serious look at fund performance analyst Moneyspider.com. Remember, today’s star performer could easily turn out to be tomorrow’s dog!

Tony Ahearne, Director, Moneyspider Limited.
Tony has been an Independent Financial Advisor for over 30 years. (The above article is based on the author’s understanding of the new rules and investors are advised to take their own professional advice.)"Many of our members now check their funds on a daily basis."
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