Diversification is an investment strategy that lowers your portfolio’s risk and helps you get more stable returns.
You diversify by investing your money across different asset classes — such as shares, property, bonds and private equity. Then you diversify across the different options within each asset class. For example, if you buy shares, you buy across a range of different sectors such as financials, resources, healthcare and energy. You can also diversify by investing your money across different fund managers and product issuers.
Diversification lowers your portfolio’s risk because different asset classes do well at different times. If one business or sector fails or performs badly, you won’t lose all your money. Having a variety of investments with different risks will balance out the overall risk of a portfolio.
It’s worth taking the time to review your investments and look for opportunities to diversify.
How diversification benefits you
Diversification is your best defence against a single investment failing or one asset class performing poorly (for example, the share market falling or one fund manager failing).
If you diversify your investments, when some fall in value, others may rise and balance out the fall. Diversification lowers your portfolio risk because, no matter what the economy does, some investments are likely to benefit. For example, when interest rates fall, bond prices rise, while shares generally do poorly at this time.
How to diversify
To diversify well you need to invest across different asset classes and within different options in an asset class. You can also diversify by investing in different fund managers or product issuers.
Review your investments
List all of your investments and what they’re worth. This could include:
cash in a savings account
an investment property
This will show you which asset classes you’re investing in and where you could diversify.
Identify gaps and research other asset classes
If most of your money is in one or two asset classes, research other asset classes. For example, if you own a house, an investment property won’t help you diversify. If property prices fall, you won’t have any other investments to balance out the fall. To diversify, you could invest in different asset classes such as shares or bonds.
Then within each asset class, make sure your money is invested across the different options available. For example, if you’re mainly invested in one sector such as financials, you should research other sectors such as mining, materials, health care, capital goods and commercial and professional services.
The way your super fund invests is a good example of diversification. Check your fund’s website or annual statement to see how they invest.
Australia has a small share of the world’s investment opportunities. Investing some of your money overseas will lower the risk of investing in a single market. For example, investments in Asian and European markets may perform well when the Australian markets falls.
If you invest overseas you’ll be exposed to exchange rate risk.
Invest through a managed fund, managed account, ETF or LIC
A simple way to diversify is to invest through a managed fund, managed account, exhcange-traded fund (ETF) or listed investment company (LIC).
Managed funds and managed accounts
Managed funds and managed accounts can help you invest across a range of asset classes. Some managed funds and managed accounts offer pre-made diversified portfolios. These usually have the labels of conservative, growth or high growth depending on their asset allocation.
ETFs and LICs
ETFs and LICs provide a low cost way to invest in an asset class or diversify within an asset class.
Most ETFs in Australia are passive funds. These track an asset price or market index, such as the ASX200 or S&P500.
Most LICs are actively managed funds and invest in one asset class, such as Australian shares or private equity.
Before you invest in a managed fund, managed account, ETF or LIC speak to your adviser and read the product disclosure statement (PDS). This shows you where the fund invests, key features and benefits of the fund, the expected return, risks, fees and how to complain.
Keep your investments diversified
Over time, some of your investments will rise in value and others will fall. This means you could have more money in one asset class than when you started investing. You could also be less diversified. For example, if your shares go up and your bonds fall in price, you’ll have a greater portion of money invested in shares. As shares are higher risk, your portfolio will also be higher risk. If you’re not comfortable with this risk, it’s time to re balance.
How to rebalance
You can rebalance your portfolio by:
Investing some extra money, such as a tax refund, in an investment you want more exposure to.
Selling some investments and putting your money in other types of investments.
Selling investments will lead to a capital gain or a capital loss.
Get help with diversification
Finding the right investments can be challenging. If you need some help to build a diversified portfolio, talk to us.
Reproduced with the permission of ASIC’s MoneySmart Team. This article was originally published at https://moneysmart.gov.au/how-to-invest/diversification
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