The art of portfolio diversification

04 Jun 2019

By Belinda Von Knoll

How many of us have heard the saying ‘Don’t put all your eggs in one basket’? It may be a cliche, but when it comes to your portfolio strategy, there is perhaps no better piece of advice.

During times of volatility, one of the most common misconceptions we hear is how Australia is the only safe place to invest (preferably in cash), and that the rest of the world should be avoided.

But if you look at where your portfolio would be now if you spent the last 10 years investing in cash, at 31 December 2018, you would have achieved returns of just 3.1% per annum – barely enough to cover inflation.

And how did Australian shares fare over the same period? They returned 8.9% per annum – Australian Fixed Interest 5.2% and International Shares 9.6%. In other words, International Shares trumped cash and Australian shares for the last 10 years – yet very few of us would have been comfortable putting all investments there recently.

“Timing” the market simply doesn’t work

Let’s look at another example: during the year ending 31 December 2018, International Shares returned 1.4%, while Australian shares returned -3.1%, Australian Fixed Interest 4.5% and cash 1.9%. Could you have predicted at the beginning of 2018 that it would be wise to move out of Australian shares and into Fixed Interest?

It’s been demonstrated time after time: those who try and time the market consistently fail. As you can see in the chart below, rarely is any sector of the market the best performer for more than two years in a row. That’s why portfolio diversification – allocating investments among various financial instruments, industries, and other categories – is so important.

Source: refer to disclaimer text below 

Portfolio diversification: Reaching your goals while minimising risk

Most experts agree that, although it doesn’t entirely safeguard against loss, diversification is one of the most important factors in reaching long-term financial goals while minimising risk. This is because spreading your capital amongst different investments ensure you’re not reliant on a single investment for all of your returns.

With a diversified portfolio, if one investment takes a hit, you aren’t impacted as significantly as you would be had you put all your capital into that one investment.

Where to start with diversifying your portfolio

There’s no one-size-fits-all approach to investing, and choosing the right spread for your portfolio should depend on your goals and financial situation. However, as a guide, you should:

  1. Start by identifying your goals and objectives
  2. Work out a risk profile that aligns with your goals but also ensures that you can “sleep at night”. For example, if you’re nearing retirement, you might choose investments with lower risk but lower returns, such as cash investments.
  3. Determine your asset allocation. Effective asset allocation has been demonstrated to be responsible for 90% of long term investment performance.

Remember that within your allocation to each asset class, it’s a good idea to diversify each asset class across a range of countries, companies and industries. This will help smooth your returns, reduce volatility, and, ultimately, help you achieve your long-term financial goals.

Contact us on 1300 308 440 to talk to a financial adviser.

Source: In Australian dollars. Data is the annual return to 31 December 2018. Data used for each asset class is as follows: Australian Large: S&P/ASX100 Index (Total Return), Australian Small: S&P/ASX Small Ordinaries Index (Total Return), Australian Value: S&P Australia BMI Value Index (gross dividends), Property: S&P Global REIT Index (gross dividends), Global Large + Mid: MSCI World Index, (gross dividends), Global Small: MSCI World Small Cap Index (gross dividends), Global Value: MSCI World Value Index (gross dividends), Cash: Bloomberg AusBond Bank Bill Index, Emerging Markets: MSCI Emerging Markets Index (gross dividends), Fixed Interest: Bloomberg Barclays Global Aggregate Bond Index (hedged to AUD). S&P data © 2019 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. MSCI data © MSCI 2019, all rights reserved. Bloomberg Barclays data provided by Bloomberg. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio.

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