Why you should spread your investments in the current market
So back to basics… what is diversification?
Diversification is about ensuring your money is spread across a range of investments, in keeping with your philosophy and strategy.
It aims to give you growth and income sources from assets that perform differently, at different points in time and with different factors driving performance.
Diversification includes spreading your investments across:
- Asset classes: equities, fixed income, property, commodities, alternatives, currencies
- Regions: look beyond Australia to the US, Europe, Asia and Africa.
- Sectors: i.e. don’t stick all your money in tech, consider other sectors like healthcare, consumer staples or materials, to name just a few.
- Investment styles: income, alternatives, contrarian, growth, value, just to name a few.
- Risk levels: some investments bear a higher risk of loss of capital, some have a lower risk. The higher risk assets tend to be growth investments, whereas the lower risk are more likely to be defensive assets.
A simple example of diversification
Sometimes the best way to explain something is to demonstrate it. So, here’s a very basic example using diversification across sectors in equity investments.
Qantas is forced to shut operations and its share price and earnings are hit hard. Your portfolio is feeling it. But… Woolworths is thriving. Everyone is ordering their online grocery delivery, the shelves are empty of toilet paper and it’s great for share prices and earnings. It’s become a buffer for your portfolio. Maybe it’s more than offset Qantas if you are lucky. Even better, the pandemic eases, borders open and Qantas resumes operations. So you have the chance to still benefit from the change in circumstances.
More data to back up the case
This table from Schroders shows how key indices representing different asset classes have performed over the years, with each asset class ranked top to bottom. For example, last year, the top performer was global equities while the bottom was Australian fixed interest. But the previous year, the top performer was global emerging markets and the bottom was Australian property trusts. You can also scroll through the chart here.
Essentially, the top performer in one year is not necessarily the top in another year so having a blend of asset classes helps.
How to diversify?
Start with your strategy and risk profile
If you know what your goals are and what level of risk you can comfortably take on in your portfolio, then you can work out what mix of assets and investment styles are likely to help you achieve that. For example, your strategy might involve a traditional 60:40 balanced portfolio. This represents 60% growth assets, such as equities and 40% defensive assets, such as fixed income. A financial adviser can assist with this process and the ongoing management of your strategy.
- Identify a blend of assets and investment styles that fit in with the strategy and avoid overconcentration into a particular sector or region.
Regular portfolio checks and rebalancing
Market movements can mean your investments start to drift away from your strategy and ideal portfolio composition. Some holdings may grow, and others may shrink. This can change the risk profile of your strategy and mean you are less diversified than you intended. By regularly checking your investments and rebalancing as needed, you can keep it on track.
Frequently asked questions
Diversification means ensuring your investments are spread across asset classes, sectors, regions, investment styles and risk levels.
Why should you diversify your investments?
How can you diversify your investment portfolio?
This article is part of our Investment Guide series. If there is a topic you would like to learn about next, please leave a comment below.
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Sara is a Content Editor at Livewire Markets. She is a passionate writer and reader with more than a decade of experience specific to finance and investments. Sara's background has included working at ETF Securities, BT Financial Group and...