A good investment strategy requires balance. Don’t put all your eggs in one basket, right?
Are you wanting to take action with your money and invest for the future?
If your answer is yes, this article will help to provide insight into why you should and how you can start to diversify your investments.
Deciding how best to invest can be a time consuming, challenging and stressful process. Particularly, given the number of variables involved and of course, the fear of having your financial future at stake. If you’re new to investing, it would be worth reading our article 5 Key Things To Consider Before You Start.
Let’s explore what diversification is and how it will benefit your investment portfolio.
What is Diversification?
Simply put, diversification is a risk management strategy used by investors to spread their investments across a variety of asset classes or locations to minimise impact through the ups and downs of the market.
Given each asset class has its own economic cycle, having a diverse investment portfolio can help you by:
- Reducing your exposure and likelihood of losing all of your money due to a single business or sector performing badly
- Spreading the risk across your investments
- Enabling you to withstand the ups, downs and swings of financial markets
- Ensuring that you’re not relying on a single asset class for all of your returns and profits
- Reaping the rewards when an asset class’ economic cycle is in a boom
Should You Diversify Your Investment Strategy?
The simple answer: Yes! A good investment strategy requires balance. Don’t put all your eggs in one basket, right?
Changes in the macroeconomic environment can have varying effects on different assets. Financial downfalls, such as the global financial crisis of 2008, can have an impact on all assets no matter their class or industry.
We can break risks associated with investing into 2 main categories:
- Undiversifiable Risk – Which has the potential to impact every asset class.
- Diversifiable Risk – Which tends to be specific to a particular company, industry, market, economy or country.
As an investor, you have very little control over undiversifiable risk as it is not specific to a particular company or industry, and cannot be eliminated or reduced through diversification.
Common causes include inflation rates, exchange rates, political instability, war and interest rates.
However, diversifiable risk can be reduced by investing in various assets. This is because not all assets are affected the same way by specific market events. The most common sources of diversifiable risk are business performance and financial markets.
Regardless of which type of investor you are, it’s important to strive for both high-quality and diverse investments that suit your risk tolerance level and overall financial goals.
Many newbie investors make the mistake of favouring one asset class (eg. buying an investment property), but end up missing out on superior opportunities with greater returns. They tend to avoid other investment opportunities due to a fear of stepping outside of their comfort zone.
If you’re a newbie investor, please check out this 10 Important Tips to Be a Successful Investor. It will give you some great pointers to get you started.
How To Diversify Your Investments
There are a number of ways to diversify your portfolio. You can start by spreading your investments across different asset classes including:
• Fixed Interest
If planning to invest mostly in property, you can diversify by purchasing property in different states across Australia, rather than just in your own capital city.
If planning to invest in shares, you can bring more diversity to your portfolio by owning different types of stock. For example, from different companies, sectors and industries or simply an index fund.
In terms of how diverse your portfolio should be, it truly depends on your goals, risk tolerance, investment preferences and when you plan to retire. It’s important to strive for a well-balanced portfolio representing the major sectors, industries and asset classes. Diversifying is not only about what you buy, but when you buy it.
Age can also have an impact on how much you diversify your portfolio. For example, if you’re in your 20s or 30s you may feel more comfortable taking on a higher level of risk. You may even have a more aggressive investment mix focused on high return strategies.
You may also be more focused on capital growth rather than earning an income stream, which is a common preference for those nearing retirement.
We have had many clients come to us feeling nervous, overwhelmed and tentative about stepping out of their comfort zone and entering the investor-sphere.
But, as soon as they realise that they’re surrounded by a team of experts providing continued guidance and support, they are able to relax knowing that we will lead them in the right direction to make the best investment decisions.
I hope this article has given you some clarity as to why diversification is an important part of developing a successful long-term investment strategy.
If you’re interested in attending one of our live investment workshops, click here!