It would seem common sense not to put all your eggs in one basket, but you’d be amazed at how many investors - even professional ones - forget.
Just as a healthy diet means eating a range of different foods, a healthy portfolio should include a number of different assets.
The main reason for diversifying is to avoid the risk of being too heavily concentrated in one particular stock, sector, country or asset class.
Another reason is to reduce volatility. Historically, equities have produced higher returns than bonds or cash. But in the short term share prices can be very volatile.
So, holding bonds, and if you’re very cautious, cash, in your portfolio alongside equities can smooth the ride to your investment goals.
This is the Periodic Table of Investment Returns, produced each year by Callan Associates.
The asset classes are colour-coded, and each column illustrates the returns for a particular year - the best performer at the top, the worst at the bottom.
The table shows us there are no reliable patterns or trends you can take advantage of. This year’s top performer often turns into next year’s biggest loser.
However it also demonstrates how, over the long term, asset class performance tends to revert to the mean.
Holding the whole market removes the need for guesswork - saving you time, money and unnecessary anxiety.
So the fourth step to successful investing is to spread your risk.