The Benefits of Diversification
There’s an old saying that “you shouldn’t put all your eggs in one basket”. It’s especially true when it comes to investing.
Diversification in the investment context means investing your money into different asset classes and markets. In other words, not investing all your money into a single asset class or market. That would be the equivalent of putting all your investment “eggs” in one “basket”.
There are two key benefits of diversification:
1) minimising the risk of investment loss (preserving your capital).
2) not relying on a single asset class to provide you with investment returns.
Diversification your investment portfolio means you’re not as exposed to market fluctuations.
Risk and return
All forms of investment (for example, fixed interest securities, property and shares) have a degree of risk associated with them. It’s important to understand that the higher the potential investment return, the higher the investment risk, and vice versa.
For example, fixed interest securities like term deposits and bonds are low risk, but they also only offer low returns. If you invest solely in this asset class, you’re missing out on the opportunity for higher returns
Share and property investments on the other hand have a higher level of risk. They also offer higher potential levels of return, but their investment value can fall as well as rise. However, both the Australian share and property markets have long-term growth trends, even though their investment value can potentially fall in the short term.
For example, during the global financial crisis of 2007/08, the value of the Australian share market fell by 54% over a sixteen-month period. Investors who were heavily exposed to the share market (in other words, not diversified) were significantly affected. Many had to delay their retirement plans as a result. However, over time, the market recovered. Property markets in many Australian capital cities have also experienced a downturn over the last year or two.
Investment returns in different markets can be affected by a range of factors, including:
- general economic conditions, such as interest rates.
- the market forces of supply and demand.
Your investment risk profile
It’s important for your investment portfolio to suit your investment risk profile. This profile describes your ideal level of investment risk. It can be affected by a number of factors, including:
- your personality and general attitude towards investment risk,
- your financial goals, and
- your stage of life. For example, if you’re in retirement, you generally can’t afford to take a risk with your nest egg because you’re no longer working and earning an income.
It’s important to regularly review your investment portfolio as your needs and circumstances will inevitably change over time.
How to diversify
You can diversify to reduce your investment risk in three main ways:
1) by investing in a range of different asset classes.
For example, having a diversified investment portfolio with an appropriate mix of property, shares and fixed interest securities that matches your investment risk profile.
Investment markets tend to go in cycles. When one market is performing strongly, another may not be. You can balance out these fluctuations by spreading your investments across different asset classes and markets.
2) by spreading your investments within an asset class.
For example, by investing in a managed share fund that invests in a range of companies, rather than buying individual shares in a single company.
3) by spreading your investments over time.
For example, if you buy shares at regular intervals, you can reduce your risk of buying at the top of the market before a price fall. Instead, you’ll be buying at a range of prices over time, rather than at a single price. It’s a smart strategy, because no-one has a crystal ball to know when share markets are going to rise or fall.
How we can help
At Qi Wealth, our experienced, expert team of financial advisers can help you to diversify your investments to suit your risk profile. We’ll take the time to understand your individual circumstances so that we can provide you with the best possible advice to help you achieve your financial goals. We develop long-term, trusted relationships with our clients.
Contact us today to find out how we can help you!