Diversification

Don't put all your eggs in one basket

Diversification helps you ride out the ups and downs of financial markets by spreading your money across different asset classes. It will leave you less exposed to a single economic event, so if one business or sector you've invested in isn't performing well, you won't lose all your money .

Diversification reduces overall investment risk and reduces volatility of returns on your investment portfolio as a whole.

How diversification works

Diversification won't guarantee gains or protect against losses, it's about managing the risk/reward trade off by selecting a mix of investments to help you achieve more consistent returns over time.

Assets that carry a higher risk should deliver a higher reward but are also likely to have more volatile returns over the short-term. You can offset some of this risk and volatility by including assets that have lower risk and return but lower short-term volatility.

In addition, markets for different asset classes peak at different times, which means when returns for one asset class are high, returns for a different asset class may be low. By having your funds spread across a number of different investment types, your overall returns will be less volatile as low returns or losses on one investment are offset against high returns or gains on another.

Sometimes things don't go according to plan and occasionally a company you have invested in will make a loss or fail completely. If you are well diversified and have limited your exposure to any single asset you will be less likely to suffer a big loss if this happens.

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Read our booklet

Read our Investing between the flags booklet to find out how to develop a sound investment plan.

How to diversify

To create a diversified portfolio start by investing across different asset classes. An ideal investment portfolio will include some investments that have a higher risk and reward (growth assets) and some investments with a lower risk (defensive assets) and reward. The proportion of each type of asset will depend on your investment time frame and your personal risk tolerance. See goals and risk tolerance and choose your investments for more information.

Once you've considered the major asset classes; cash, fixed interest, bonds, property and shares, think about diversifying further by choosing different sectors within each asset class. 

Don't forget to take into account lifestyle assets you may already have. For example, if you already own (or are paying off) a home, using all your money to buy another residential property would be an example of poor diversification.

When adding to your investment portfolio, consider whether the investment will further diversify your portfolio or whether you are concentrating your funds into a single asset class.

Invest in different industries

Different asset classes perform better at different times, as do industry sectors within an asset class. The following graph shows how different sectors of the Australian share market have performed over time. Note how some sectors are more volatile than others.

Sectors of the Australian Sharemarket

Graph showing sharemarket performance from 2000-2014

Source: Australian Securities Exchange and Thomson Reuters 2013

Invest in different markets

Australia has a relatively small share of the world's investment opportunities. Investing some of your money overseas will reduce your exposure to a single market. Different markets will also peak at different times, for example, Asian or US markets might be up when Australian markets are down.

Be aware that when you invest in international markets you have the added risk that changes in currency exchange rates can increase or reduce your investment returns.

You can invest in overseas markets directly or through an overseas share option in a managed fund, ETF or super fund. Seek financial advice if you need help getting started or managing the risks.

Spread your timing

'Timing risk' is the chance that your investments will suffer because of when you buy or sell your investments. For example, you buy an investment just before a big price drop, or sell just before the price goes up.

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.

Test your knowledge

You can test your knowledge of diversification and other key investing concepts by taking our investing challenge.

Investing challenge

Diversification within managed funds and super

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.

Different investment fund managers have different styles of investing. Rather than relying on one investment manager, funds may employ a number of investment fund managers to manage specific parts of a given portfolio. This allows you to benefit from the expertise of a number of managers within one product. 

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. If you have chosen an investment option that uses multiple investment managers over different asset classes you will be diversified.

Both funds may even be using the same investment managers so unless you have chosen multiple funds because they are investing in very different assets, focus on diversifying within a fund rather than having multiple funds.

SMSFs

If you have a self-managed super fund (SMSF), you are responsible for making investment decisions for that fund. Think carefully about your mix of investments and how appropriate the mix is in terms of your risk tolerance and your fund's primary purpose of accumulating funds to live off in retirement.

Follow the same principles of diversification and don't be tempted put all your money in any one sector of the market, for example property, if that that is not in line with the fund objectives. See SMSFs and property for more information.

Case study: Dominic chooses a 'growth' investment option

case-study-long-term Dominic uses a diversified investment mix to build his retirement savings in his super fund over the next 15 years.

How to keep your investments diversified

Once you have a mix of investments that meet your needs, keep it on track with regular check-ups and rebalancing.

Review your investments regularly

How often you review your investments will depend on the type of investments you have. If you have invested in a type of managed fund, an annual review to make sure the fund returns ae in line with expectations and that the investment mix is still appropriate for your needs, may be sufficient.

If you have invested in direct investments, such as shares, you will need to review your investments much more frequently, and keep an eye out for any news or company announcements that may affect your investments.

Investment returns can alter the percentage mix of your investment portfolio over time. If your investment mix moves away from your target by more than 10% you may want to consider rebalancing your portfolio, to maintain your desired level of different asset classes.

How to rebalance

You can rebalance your portfolio by selling assets you currently have too many of and reinvesting the proceeds in types of assets that fall short of your target allocation. Selling may have tax consequences, so be sure to consider this before making any decisions to sell. See make tax work for you for more details.

Another way to rebalance without immediate tax consequences is to invest any extra money you might have (such as ongoing contributions or your yearly bonus), in asset classes that are currently below your target allocation.

Diversification is about spreading your investments over a range of assets, managers and markets. Diversification will not ensure against loss, but will help even out returns over your portfolio as a whole by reducing overall valatility.


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Last updated: 22 Jan 2016