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Why diversification is the only ‘free kick’ when investing

Date: 14/12/2021

Spreading investments and lowering risks is a smart strategy that consistently delivers positive long-term financial returns.

There is a reason why financial advisors often tell investors not to put their eggs in one basket.

A diversified portfolio blends different investments into a portfolio and is a proven way of delivering sound long-term financial returns while also minimising risks. By contrast, if you have all your money tied to one sector and the market crashes or slides, you can suffer significant financial losses.

For those who are close to retirement and want to preserve capital, a diversified portfolio can also provide peace of mind and protect your savings.

In this sense, diversification is really the only ‘free kick’ investors can get in markets that historically will experience ups and downs over time. It also eases pressure to pick ‘winners’ among asset classes each year – a gamble that is all but impossible because market conditions can change so quickly. Think COVID-19.

The downside of diversity, of course, is that you will never get the absolute highest possible financial return because some asset classes within your portfolio will inevitably perform more moderately than others.


Three key asset classes

The three main asset classes that typically dominate a diversified investment portfolio are shares, property and bonds. Spreading your money across these areas provides a form of insurance in case one performs poorly.

You can also diversify within each asset class. For example, when buying shares it makes sense to target a range of different sectors, such as banks, resources companies and healthcare organisations.

While most investors are familiar with shares and property, they may be less knowledgeable about bonds. They are important, though. Bonds are fixed-income instruments whereby investors provide capital to borrowers such as corporate or government entities.

While they are not seen as sexy, they are ideal for investors with a low risk appetite because when held to maturity they can offer stable and consistent returns.

How your advisors can help

A lot of DIY investors will hear investment tips from their friends at a barbecue, or read stories in the press or on social media about a hot stock or property opportunity.

They may then try to ‘time’ the market – that is, pick which assets will be the next big thing in financial markets. It is a dangerous way to invest. A lot of those amateur forecasts are uninformed and represent ‘noise’ around the market that may not be relevant to your risk profile.

Experienced financial advisors can maximise the chance of stable financial returns and minimise downsides. It is our job to assess and understand a client’s risk and to then structure a portfolio around that risk profile.

Smart advisors can also help you invest your money across different fund managers so you have access to diverse investment philosophies. That avoids a potential problem if, for example, you have two different providers with similar investment styles who are managing your Australian and global share allocations.

Test your scenarios

A key part of an advisor’s work is to do scenario testing with clients, asking you how you might react to a high-performing market – and, more importantly, how you will feel if a market slides and you lose money. That feedback sets the gauge for how the advisor will construct a suitable investment portfolio – and offer the prospect of sound long-term financial outcomes.

The bottom line is that investing should be fun and rewarding. By taking a disciplined approach and using diversification – with some input from an experienced advisor – it is possible to invest successfully and strategically.

To find out more about building a well-structured investment portfolio, or just to get a second opinion, speak to one of our Adrians Private Wealth partners.