The benefits of diversification in your portfolio
Remember the old saying “Don’t put all your eggs in one basket?”. It’s a good rule to follow when you’re investing. Diversification offers many benefits, including more resilience in times of market volatility and more stable overall returns.
In investment lingo, the term ‘diversification’ means apportioning your funds into various assets, or to use the analogy, placing your eggs into a number of different baskets.
Diversification offsets risk
While some investments might perform well in any single year, others may not. Overall, a balanced portfolio mitigates your exposure to this kind of market volatility.
You can’t judge investments by their past performance, nor can you accurately predict their future performance. But a good investment strategy will balance your portfolio across both growth and income-based investments, proportioning your risk.
Growth assets typically include property, shares and managed funds, and defensive investments may be simple cash accounts, term deposits, or certain managed funds that pay regular income distributions.
How can I diversify my portfolio?
While simple diversification involves allocating your investments across different investment types, such as cash, fixed interest, property or shares, you can also consider diversification within each of these asset classes. For example, a mixture of Australian and international shares, or by choosing shares across various segments of the market such as technology, financial, mining, retail and pharmaceutical stocks to name a few.
All investments are subject to volatility
Markets are cyclical. The Australian property market is currently a good case in point. Having outperformed all predictions over the past decade, it is now ‘slowing down’. Or as the real estate market experts say, ‘cooling off’. What this means is that we’re likely to see a dip overall in house prices, more stability in pricing, slower capital growth, and longer selling periods.
But of course, like any market – real estate is subject to a range of economic factors such as interest rates, employment rates, population and infrastructure growth – the list goes on. And then, to complicate the issue, while the capital cities tend to follow similar market cycles and timing, other areas such as satellite cities and tourist towns can be stand out anomalies and go against all the predicted trends.
The point is, that while broad assumptions about the performance of any market can be made, at any time, based on various theories and hypotheses, the fact of the matter is that without a crystal ball, it’s impossible to know exactly what to expect or when the high points and low points will be.
And this exactly why diversification will serve you well. Not all investment markets perform in sync with each other – when one asset may be rising in value, another may be falling. Diversification smooths out the bumps – giving you a better overall return.
Diversified portfolios are more resilient
There is always a temptation to make high returns (especially in the short-term) by investing heavily in the current ‘best performing’ asset or shares. But the risk is having all your funds in one place and experiencing a significant down turn. There is also risk in not picking the perfect time to ‘buy’ or ‘sell’ for maximum return.
On the other hand, a diversified portfolio will be more resilient and provide more stable returns in the medium and longer term. With that said, investments should not be a ‘set and forget’ proposition. They should be reviewed regularly, and you should seek professional advice from an accredited financial planner who will not only help you devise the right strategy and choose the appropriate portfolio, but ensure that you’re compliant with any rules and regulations as well as tax implications.
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