When you start investing, or even if you are a sophisticated investor, one of the most important tools available is diversification.

Whether the market is bullish or bearish, maintaining a diversified portfolio is essential to any long-term investment strategy.

Diversification allows an investor to spread risk between different kinds of investments (called ‘asset classes’) to potentially improve investment returns. This helps reduce the risk of the overall investments (referred to as a ‘portfolio’) underperforming or losing money.

With some careful investment planning and an understanding of how various asset classes work together, a properly diversified portfolio provides investors with an effective tool for reducing risk and volatility without necessarily giving up returns.

Understanding investment risk and determining what level of risk you feel comfortable with before you invest is an important part of the investment decision process. Your potential returns available from different kinds of investment, and the risks involved, change over time as a result of economic, political and regulatory developments, as well as a host of other factors.

Your overall asset allocation needs to reflect: your future capital or income needs; the timescales before those capital sums are required or the level of income sought; and the amount of risk you can tolerate. In addition, it is important to bear in mind your ‘capacity for loss’. This is the amount that you can afford to lose without it affecting your lifestyle.

Investing is all about risk and return. Not only does asset allocation naturally spread risk, but it can also help you to boost your returns while maintaining, or even lowering, the level of risk of your portfolio.Most rational investors would prefer to maximise their returns, but every investor has their own individual attitude towards risk.