How to diversify your investments

We have all heard the phrase don’t put all your eggs in one basket. This is especially important when it comes to investing whether it be in super or not.

What is a diverse investment portfolio

Broadly, there are four types of assets you can invest in. Businesses, commercial and residential property, infrastructure, and fixed interest. However, the number of asset classes increases when you include both Australian and overseas assets.

You can break each asset type into smaller sections. For example, businesses can be broken down into sections such as financial services, energy, healthcare or technology.

Many people think they have a diversified portfolio if they invest in the four large banks, Telstra, BHP, and Woolworths. While this may have done well over the last 20 years, when the Australian economy takes a hit, all these companies will be impacted.

Four reasons why you should diversify your investments

Before I go into why you should diversify your investments, I should start by saying that diversification isn’t about just getting the highest returns. It is about minimising the risks.

Diversification helps investors ride out the ups and downs of the individual markets. Just because a particular investment has done well for the past 10 years does not mean it will continue to do well. For example, the US market has been the best performing asset class over the last 10 years with average annual returns of 13%. However, if you look at the 10 years before that, it had average annual losses of 2.5%. Who knows what the future holds.

The second reason is that holding different asset types will help spread your risk. This is important as no-one can accurately pick whether banking, technology, infrastructure or property will perform the best in the next 5 years. The Australian stock market is dominated by the big four banks, where the US stock market is more heavily weighted towards technology companies. It is important to have both in your portfolio.

Thirdly, diversifying your investments allows you to better match your investments with the amount of risk you are comfortable with taking. As a rule, fixed interest is less risky than stocks and diversifying will allow you to have a mix of both that suits you.

Finally, holding assets from different parts of the world reduces your reliance on one particular region. In Australia this is important, as the value of the Australian stock market is only 2% of the whole world.

How to diversify your investments

We generally recommend low cost, broad based index funds rather than individual stocks. We do this as picking stocks is very hard to do. History shows that of all fund managers only 15% beat the index they track over the long-term. That is, they aren’t able to consistently pick the right stocks.

Here is how we would put together a diversified portfolio for a balanced investor. A balanced investor is one that doesn’t want or need to take unnecessary risks. A balanced investor has around 50% of their assets in conservative assets. 20% in an index that tracks the top 200 Australian stocks; 20% in an index that tracks the top 1,500 international stocks; 10% in an index that tracks international property and infrastructure; and the remaining 50% in an index that tracks Australian and/or international fixed interest and bonds.

A portfolio like this would give you exposure to a wide range of investments for the lowest cost.

If you would like to discuss your current or future investments, book a chat via the button below. Alternatively contact us on 0417 034 252 or at office@constructwealth.com.au.