The old saying "Don't put all your eggs in one basket," is a fundamental truth in investing. If you put all your eggs in one basket and something unexpected happens to that basket, you're likely to lose most, if not all, of your eggs.
Diversification involves using a variety of “baskets” in which to carry your “eggs”, and is a proven method of reducing investment risk. By spreading your money around different investments, you're increasing your chances of achieving your financial goals.
Where do I spread my money?
Your investments should be spread across and within, asset classes. Generally speaking, there are two types of asset classes - Growth Assets and Income Assets. Growth assets include New Zealand and international shares, property, infrastructure and development capital. Income Assets include cash and fixed interest.
How do I diversify?
For many New Zealanders, their home is their major investment. This means that most are sufficiently exposed to the property market. Your next focus should be diversification across any investments you may hold now or in the future.
Putting money in a managed fund that invests across shares, commercial property, fixed interest and some short term cash means your money is diversified across different asset classes. At any given time, one or two of these assets may be doing well, and one or two are likely to be under performing. Your fund manager will be balancing these performance levels and endeavouring to maximise your return.
Can I diversify within Asset Classes?
Within each asset class there is potential for further diversification.
- Within the share portfolio you may have some New Zealand shares and some international shares.
- Within international shares you may have shares across 20 different countries.
- Within each country, you may have shares from three or four different industry sectors, like technology, tourism and telecommunications.
- Within each industry sector you may actually hold shares in a number of different companies.
Thus, diversification spreads the risk of these individual investments around, so that when the unforeseen happens the impact is lessened. One stock can fall to zero, stocks as an asset class can’t fall to zero.
This is one of the major benefits of managed funds. Your money is part of a pool of individual investors, so you can spread your dollar a lot further that you could manage on your own.
What's the right balance?
The way you choose to diversify your portfolio across and within asset classes will depend on your investment objective, your time horizon, your age, your current financial position and your risk profile.