Why your investment portfolio isn’t complete until it’s diversified
Diversification is essentially the idea of not putting all of your eggs in the same basket, but take a look at a slightly more technical explanation, and the reasons behind why it’s a good thing.
The definition of diversification
Imagine that you did put all your eggs in one basket – then the handle broke and you lost all your eggs.
Diversification is a risk management strategy that makes it virtually impossible to ever lose all of your investments at once. Even if one or two fall apart in some way, you still have the others to continue accruing revenue, so those losses don’t hinder your progress in any major way. The theory is that you’ll therefore create higher average yields whilst minimising any risks through investment in several areas, rather than just one.
For example, you could invest into a range of areas such as property, bonds, exchange-traded funds, stocks, or even commodities. Typically, you’ll aim for a mix of low-risk and low-reward investments (defensive assets) and high-risk and high-reward investments (growth assets) for a well-balanced portfolio.
Benefits of having a diversified portfolio
Naturally, the minimisation of the risk of losing all of your principal through one poor investment is one of the best reasons for diversification. Note that it doesn’t completely eliminate risks altogether, but it does keep them to a manageable, financially sensible level.
Almost all markets rotate between ‘bull’ (where prices are rising) and ‘bear’ (where prices are dropping), with steady periods in between. Diversification within a portfolio is a standard way of maintaining a solid average even when the market goes through times of volatility. As one market plummets, another may soar, giving the portfolio owner an acceptable average.
As well as improving the average returns your investments accrue, diversification can also lead to smoother returns. Instead of seeing huge benefits in one quarter then negative figures the next, a variety of assets in your portfolio can smooth these figures out for a straighter line on your returns graph in the long term.
Finally, there is such a thing as ‘timing risk’. This is where prices can drop right after you invest in a market, or they rise right after you’ve sold. The Australian Securities and Investments Commission’s MoneySmart website offers diversified portfolios as the best defensive strategy, stating that “investing at regular intervals, such as monthly or quarterly, will reduce timing risk. Similarly, selling investments in stages can reduce timing risk, if it suits your needs.”
Are you looking to start an investment portfolio of your own, or diversify an existing one? Chat to an experienced financial planner to find out how.
This information is of a general nature only and has been provided without taking account of your objectives, financial situation or needs. Because of this, we recommend you consider, with or without the assistance of a financial adviser, whether the information is appropriate in light of your particular circumstances and needs. Financial planning services are provided by Eastwoods Wealth Management Pty Ltd ABN 17 008 167 002 / AFSL 237853 trading as Beyond Bank Australia Wealth Management. Eastwoods Wealth Management Pty Ltd is a subsidiary of Community CPS Australia Ltd ABN 15 087 651 143 / AFSL 237 856 trading as Beyond Bank Australia.