Diversification is a risk management strategy that involves investing across or within different asset classes to minimise the ups and downs of financial markets. In other words, diversification is about not having all your eggs in one basket.
Although having a diversified portfolio won’t eliminate risk, a well-thought out diversification strategy can help keep to reduce risk and help with gaining more consistent returns over the long run.
What are asset classes?
Investments are often divided into asset classes - categories of investments that display similar characteristics and market behaviours. Generally speaking there are four broad asset classes– cash, fixed interest, property and shares.
How does diversification work?
Diversification works by spreading investments across and within different asset classes. Because asset classes have their own unique economic cycles, when one class is making stronger returns, another may not be performing as well. By spreading your investments across and within different asset classes you’ll be in a better position to offset the volatility of individual investments.
Tailoring diversifying to suit your needs
Aside from dividing your investments across different asset classes, there are a number of other factors to take into account as well; in particular what life stage you’re at (such as early in your career or close to retirement), what your financial goals are and what your attitude to risk is.
For example, you might be nearing retirement and looking for a range of investments that will preserve your capital while also providing you with an income. If you’re earlier in your career, though, chances are you’re not as focused on earning an income stream from your investments, rather you’re interested in capital growth.
You may be more comfortable when you’re younger with taking on a higher level of risk as you’ll usually have more time to ride out periods when a particular asset class may not be performing as well (it could also offer a buying opportunity).
Strategies for diversifying
There are several different ways to create a diversified portfolio. These include:
- Spreading your investments across the main asset classes by assigning a portion of your portfolio to shares, property, fixed interest and cash
- Diversify within asset classes, such as investing in shares within different sectors. This would mean ensuring you have a well-balanced share portfolio representing the major sectors such as mining, materials, financials and consumer discretionary.
- Diversify with a managed investment. This could be a cost-effective means of gaining exposure to a range of different sectors, markets and asset classes within the one investment. You could consider investing into an unlisted managed fund or buying an ETF on the Australian share market.
- Invest in local and international markets. Rather than just having money invested in Australian markets, you could look at overseas markets as well. This is because different markets can operate on their own economic cycles as well. A managed fund or investment could be a cost-effective way to gain exposure to international markets.
- Invest at regular intervals as this can help iron out volatility in share prices and other investments. This is because the market prices tend to fluctuate over time, so making regular investments rather than all at once lessens the likelihood of only adding to your portfolio when prices are high.
Reviewing your portfolio … or opting for an investment that’ll do it for you
It’s important to review your investment portfolio regularly to make sure the asset allocation is still meeting your investment objectives.
You should also consider speaking with a financial adviser.
Things you should know
The information on this website has been prepared without taking account of your objectives, financial situation or needs. Because of this, you should consider its appropriateness, having regard to your objectives, financial situation and needs and, if necessary, seek appropriate professional advice. If a Product Disclosure Statement is available in relation to a particular financial product, you should obtain and consider that Product Disclosure Statement before making any decisions about whether to acquire the financial product. The information contained on this website does not constitute the provision of advice or constitute or form part of any offer, solicitation or invitation to subscribe for or purchase any securities or other financial product nor shall it form part of it or form the basis of or be relied upon in connection with any contract or commitment whatsoever. Any securities or prices used in the examples on this website are for illustrative purposes only and should not be considered as a recommendation to buy, sell or hold. Past performance is not a reliable indicator of future performance. This website may contain material provided directly by third parties. This information is given in good faith and has been derived from sources believed to be accurate at its issue date. While such material is published with necessary permission, no company in the Westpac Group nor any of their related entities, employees or directors (together, "Westpac"), nor the Participant, accepts responsibility for the accuracy or completeness of, or endorses any such material. This website may also contain links to external websites. Westpac and the Participant do not accept responsibility for, or endorse the content of, such external websites. Except where contrary to law, Westpac and the Participant intend by this notice to exclude liability for material provided directly by third parties and the content of external websites.