Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.
Most investors recognise that there is a trade-off when investing in the stock market. Stock markets tend to grow faster than cash or bonds in the longer term,1 but the price for that growth is greater volatility in the short-term. However, there are ways to manage this volatility and ensure it is less disruptive for portfolio returns. Diversification is a vital tool when building an ISA portfolio.
Creating a diversified portfolio is straightforward in theory. It means spreading your investments across a range of investment types, such as bonds, equities and cash, or, within your stock market investments, spreading them across different countries and sectors. It will also mean ensuring that your portfolio isn’t too exposed to specific risks, such as interest rates or the oil price.
When investing, it is always tempting to follow the herd, and gravitate to the areas that other investors are excited about.
The theory of portfolio diversification is that your investments aren’t overly exposed to a single outcome. No matter how much research and due diligence you have done before you invest, there will always be shocks. There will be new and disruptive technology, there will be pandemics, geopolitical conflict and economic upheaval. These can disrupt the best laid plans of any investor.
By holding a balanced portfolio, with a range of different investments, you are prepared for a range of outcomes. You can participate if economic growth is buoyant, but shouldn’t lose as much if there are economic shocks. While a single sector may look like it has the strongest possible future ahead, your portfolio won’t feel the full force if it suddenly becomes unfashionable and share prices fall.
Investment opportunities provided by diversification
However, while this spreading of risk is an important facet of diversification, equally important is that by diversifying their portfolio investors can maximise their opportunity set. It means they are not looking in one specific area to generate returns, but spreading their net as wide as possible. It forces investors to look at new areas of innovation, and find opportunities for growth.
Consciously diversifying a portfolio also helps avoid some unhelpful behavioural traits. When investing, it is always tempting to follow the herd, and gravitate to the areas that other investors are excited about. However, this can see investors become vulnerable to bubbles and crowded trades. Diversifying across investments helps manage this inclination.
Importantly, diversification does not mean the absence of opinion. Active investors can still express their views, adjusting their portfolios to be more exposed to the economic cycle, or more defensive if they see weakness ahead. It simply acknowledges that alternative scenarios are possible, and aims to minimise the impact if the environment does not pan out as expected.
Diversification in practice
Diversification isn’t always easy to achieve in practice. For example, it is not enough simply to blend companies that are listed in different markets, because those companies might draw their revenues from across the world. It is often assumed, for example, that UK smaller companies are solely exposed to the UK domestic economy. However, the companies held in the BlackRock Smaller Companies Trust, will often have revenues from across the world.
Equally, the correlation between asset classes can be quite different at different points in the cycle. For example, in some conditions, bonds will provide a strong diversification to stock markets. Bond markets usually do well at times of deflation, while stock markets do better when there is plenty of economic growth around2. However, there are times when this relationship breaks down. This was seen in 2022, when bond and equity markets both fell in response to a sharp rise in interest rates.3,4
Time in the market, rather than timing the market is important, with investors that miss just a handful of trading days seeing their returns slide.8
Similar patterns can be seen in stock markets. The relationship between individual markets is not necessarily clear-cut and not always static. If a single sector does very well, and an investor doesn’t rebalance their portfolio, they can find that a once-diversified portfolio suddenly looks very skewed.
There is no such thing as perfect diversification, and investors need to remain vigilant that their stay portfolios diversified.
What does portfolio diversification look like in 2025?
There are reasons why diversification is particularly important today. After a strong run for the US mega-cap technology sector, the US market now looks more concentrated than it has done for several decades. As at the end of January 2025, the S&P 500 had over 36% of its market capitalisation in its top 10 stocks.5 The last time stocks were this concentrated was the so-called ‘Nifty Fifty’ era in the 1960s and 1970s. Then, as now, a small cohort of high quality companies, including Johnson & Johnson and McDonald’s, had led markets higher.6
In common with today’s technology giants, these stocks had strong earnings and a strong pipeline of potential growth. There was also a significant valuation gap between these stocks and other parts of the market, as there is today.4 But the Nifty Fifty fell out of favour as valuations became more and more extended – the S&P 500 fell by nearly 50% between 1973 and late 1974, and in the stock market selloff, the Nifty Fifty underperformed, declining by 60%.
History does not necessarily repeat itself. The growth of artificial intelligence could continue to support share prices for this group for some time. However, it is important to recognise that it is a possibility and maintain balance in a portfolio. The arrival of Chinese challenger DeepSeek shows how quickly the assumptions about technology growth can be disrupted. Investors creating a long-term investment strategy need to ensure that they aren’t too exposed to a change in direction.
What is the long term impact of having a diverse investment portfolio?
One of the most important advantages of a diversified portfolio is that it can help keep you invested. Investors can be unsettled by market volatility, which prompts them to sell at the first sign of volatility. The well-respected Dalbar study has shown year after year that investor behaviour tends to be a barrier to higher returns, with investors buying in and selling out at exactly the wrong moments7.
A steadier portfolio can help you avoid the perils of market timing and keep you invested over time. Time in the market, rather than timing the market is important, with investors that miss just a handful of trading days seeing their returns slide.8
This stability can help you build wealth over the long term. Consistency is key. Research from the Association of Investment Companies (AIC) has shown that 32 investment trusts would have made investors more than £1 million if they had invested the full annual ISA allowance in the same trust each year9, but these ISA millionaires needed to have the confidence to invest through thick and thin, and not to panic sell at the first sign of market volatility.
How investing in investment trusts can help balance your portfolio
At BlackRock, we have a range of diversifying growth and/or income trusts. These focus on areas such as Europe, looking for European companies with long-term growth potential. The BlackRock Smaller Companies and Throgmorton Investment Trust's aim to generate growth from investment in a portfolio of dynamic smaller companies, which can provide diversification from the large cap equities that have dominated in recent years.
The BlackRock Income and Growth Trust, aims to blend income and growth from a portfolio of UK equities. The trust places great importance on the ability of a company to raise its dividends over time. This helps it branch away from traditional income sectors such as energy, mining and banks and bring in new areas such as healthcare, industrials, even technology. This gives it a different flavour to many UK equity income funds. The BlackRock American Income Trust, BlackRock World Mining Trust and BlackRock Energy and Resources Income Trust also provide a differentiated return profile.
Diversification is just as important when investing for income as it is when investing for growth. The BlackRock Frontiers Investment Trust targets companies in small, growing economies around the world, which often pay high dividends. Latin American stock markets also tend to be higher dividend markets, which is reflected in a higher yield for the BlackRock Latin American Trust.
We believe these could be potential options for a stock and shares ISA – including lifetime or Junior ISA’s - targeting capital and/or income over the long-term.
