By Damon Frith
We invest to secure a better financial future for ourselves and family, so you want to be sure that you are ready for anything that could impact your plans.
As the saying goes - 'don't put all your eggs in one basket’. Instead, reduce your exposure to risk and volatility by diversifying your investments.
Diversification matters because no one can predict how financial markets, sectors or even asset classes are likely to perform at different points in the investment cycle.
You cannot be certain that you are fully protected against events like a global financial crisis or pandemic. But by diversifying your investment portfolio, you will have improved the likelihood of a better outcome.
Diversify across asset classes
If you have a high percentage of your investments in one asset class, then you risk losing money if that asset class performs poorly.
If you spread your investments across a variety of asset classes, and multiple sub sectors within those asset classes, you may reduce the likelihood that one investment will drag down your entire portfolio.
For example, adding bonds and cash to a portfolio made up mainly of shares may lower your overall risk. And adding shares to a bond or cash-heavy portfolio may increase your overall risk, but also provide an opportunity to improve your total-return outcomes.
How to structure you investments
There’s a lot to consider when structuring your investments. Be sure your portfolio allocation reflects your goals, appetite for risk and investment timeframe.
- Diversify within asset classes - It's also important to diversify within assets classes. When investing in shares, choose shares in a variety of sectors (banks and insurance, retail, oil and gas, mining, construction and biotech) rather than just one sector. That way, if a sector goes down, you won’t go down with it.
- Match your risk to your return - There’s a lot to consider when structuring your investments. Be sure your investment allocation reflects your investment goals, your appetite for risk and your investment timeframe.
- Long-term investments - If your goals are more than 10 years away, or if you have a higher tolerance for risk, you might consider allocating a larger portion of your portfolio to shares, which historically have offered the highest potential for growth over time. Always keep in mind though that past performance is not an indicator of future performance.
- Short-term investments - If you need the money sooner – or if you like to more cautious with your money – you might consider allocating a larger portion to less volatile assets like bonds and short-term deposits. This trades the potential of higher returns for the potential of lower volatility.
- How much risk is enough? - It's important to be aware of how much risk you are willing to tolerate, how much risk you can afford to take, and whether your portfolio is diversified appropriately for that level of risk.
Diversification won't provide complete protection from short-term dips and market volatility, but it is a proven long term investment strategy that operates across economic cycles.