We’re all trying to be more savvy about our investments and planning for our future, but where to start?
A common question asked by clients looking to invest is “What is diversification”. Below is a simple outline of what diversification is and how it can relate to you.
Here is a simple definition of how diversification works: For peace of mind, diversification is about spreading your investment over a variety of assets and markets. You can do this through fund managers or even your own super fund. Diversification will not ensure against loss but will help with balancing out the returns of your portfolio overall by reducing volatility.
Benefits of Diversification:
- Minimizing the risk of loss: This is where one or more of your investments in your portfolio may be performing poorly but this is balanced against other investments in your portfolio that may be performing strongly. This balance can reduce the overall losses of your investment portfolio.
- Preserving Capital: This is usually dependent on where an investor is in their working lives. For those close to retirement, their goal would be to preserve the capital. Diversifying investment can help protect savings.
What makes a Diversified portfolio?
In order to have a diversified portfolio, spreading your capital across different asset classes can reduce your overall investment risk. Your portfolio would need to have a mix of growth and defensive assets.
- Growth assets are investments which include shares or property and can provide a long-term capital gain. They tend to have a higher risk factor.
- Defensive assets are investments which include cash or fixed interest and can provide a lower level of volatility and risk.
Diversification within a managed fund:
Investing through a managed fund or exchange-traded fund is often the easiest way to access a broad range of investments. The same principles apply to super funds. Funds will usually offer a range of investment options, managed by various investment managers.
Investments may include single sector options such as cash, shares or property, as well as pre-mixed options offering a mix of investments from different asset classes. You don’t need more than one fund to be diversified. Having 2 managed funds or 2 super funds could just mean you are paying an extra set of fees.
Essentially, diversification is about managing the risk/reward trade off by selecting a mix of investments that can help you achieve more consistent returns during a period. There are assets that carry a higher risk and thus would deliver a higher reward but could end up with more volatile returns over a shorter period and there are those that are consistent but may have a lesser return over the short period but are of benefit in the long term.
It doesn’t matter what you have but it is important that it is working the best it can be for you.
If you have any questions regarding diversification or tax, please contact John Kalachian on 02 9267 0108.