Diversification

It is almost impossible to predict how the financial markets will perform – if we could predict sudden corrections in the share market or changes in the value of the Australian dollar we’d all be millionaires. But diversifying your investments can help you take advantage of the ‘ups’ while moderating the ‘downs’.

What is diversification?

Simply put, diversification is not putting all your eggs in one basket. Or not putting all your money into just one type of investment. All investments are subject to some level of risk. Some more than others.

How can diversification help reduce investment risk?

Different types of investments perform better under different market conditions. By investing in more than one type of investment you diversify, which can help reduce the risk for your overall investment portfolio. The more ways you diversify the more likely you are to reduce your risk. For example, across

  • Different asset classes (cash, fixed interest, property, equities)
  • More than one investment in each asset class (eg several different industries and companies when investing in managed funds)
  • More than one type of fund and investment manager when investing in managed funds.

Let’s say you had all your money in just one investment and that investment didn’t perform – you would make a loss. But, if you spread your money across different types of investments you may have a better chance of including some investments that will perform.

EXAMPLE:

Simple single investment

Value on

Average annual return

Value on

1 Jan 2000 1 Jan 2005
Aus Share Managed Fund $50,000 – 3% $42,937
TOTAL $50,000 – 3% $42,937

Diversified investment portfolio

 

 

 

1 Jan 2000 Increase/Decrease 1 Jan 2005
Aus Share Managed Fund $5,000 – 3% pa $4,294
Int Share Managed Fund $15,000 + 12% $26,435
Emerging Markets Managed Fund $10,000 – 2% pa $9,039
Fixed Interest $5,000 + 6% pa $6,691
Aus Property Managed Fund $10,000 +10% pa $16,105
Cash $5,000 + 5% pa $6,381
TOTAL $50,000 + 2.6% AVERAGE $68,946
       

This example is for illustrative purposes only and does not represent the past or future return of any product or strategy offered by Thompson Financial Services.

You can have your cake and eat it! Modern asset allocation is about achieving higher returns for the same or less risk.

Effectively, investing in only one asset class means your portfolio is one dimensional. By investing across a range of asset classes, ensures you are not “putting all your eggs in one basket”, and reducing the risk. Spreading the risk in this way, allows you to take greater risk with some of your investments, accessing higher returns whilst ensuring your overall investment risk is the same or less than a portfolio invested in one asset class.