The Importance of Diversification
First published on October 10, 2017
Deciding how best to invest can be challenging and stressful because there are so many variables and, of course, your financial future is at stake. The first two major factors Tasmanians should consider at the outset are what is their risk appetite and how long will it be before they will need to start using savings.
The reality is all investments have an element of risk and you need to take risk to earn returns on your investments, but taking too much can also lead to losses. It is like sunbathing. You need sun exposure to get a tan, but too much can lead to severe unintended consequences.
Getting this balance right can seem a daunting task. This is because the performance of investment markets can be unpredictable and seemingly irrational. People can get affected by the emotion of the situation and make restless short-term decisions like selling investments for the relative safety of cash in a falling market or buying as a stock increases, when this can sometimes harm longer-term outcomes.
Trying to forecast what will be the best performing asset classes is also difficult. Even the experts fail to get this right consistently and are caught by the large swings in annual returns for some asset classes. For example, Australian shares (S&P/ASX 200 Accumulation Index) have ranged from 38% annual losses to over 45% annual gains. International shares (MSCI World ex Australia Index (Unhedged)) have ranged from 27% annual losses to 48% annual gains.
A smart way to balance downside risk and reward is to diversify your investment portfolio to help reduce the volatility of your returns over time. Diversifying means investing your funds across several different asset classes, such as property, shares, bonds and money market funds, and within this a range of different regions, companies and securities, instead of putting all your eggs in one basket.
This leaves you far less exposed to the repercussions of a sudden market shift as not all asset classes will be affected in the same way and to the same extent. However, it is important to remember that while diversification may smooth out the bumps and dips in markets it does not ensure a profit or guarantee against a loss. Diversification is also not a ‘one-size-fits-all’ practice. Your investment time horizon is a critical consideration in determining which asset classes to invest in.
If you invest conservatively in assets with low risk and corresponding low returns, your money will probably be safe but you may fail to reach your retirement target and may actually go backwards if your investments fail to keep pace with inflation. Taking the opposite approach can be equally problematic. If you invest aggressively in high risk and high return assets as your retirement age approaches you run the risk of having a bad down year and not having enough time to make up the losses with gains over later years.
Whether you are a hungry young investor looking to enter the market or a retiree looking to enjoy the twilight of your life in comfort, appropriate diversification of your investment portfolio is key. In Tasmania, there are a range of professionals available who can help you create a portfolio that will cater to your risk appetite, needed returns and investment horizon. Call MyState Wealth Management on 1300 651 600 for an obligation-free discussion with a financial planner. For more information visit mystate.com.au/wealth
Information is current as at 15 September 2017. This is general advice only and does not take into account your personal objectives, financial situation or needs and you should consider whether it is appropriate for you.