What is Investment Diversification and why is it important?
“Don’t put all your eggs in one basket.”
It’s a catch cry that has been around for hundreds of years and is often heard in the investment space.
It’s also a simple way of describing investment diversification.
Investment diversification involves a lot more than just a blanket approach of placing your investments anywhere and everywhere in the hope of a positive outcome.
We dive into what diversification can mean for investment returns and how positive results may still be achieved in a downturn.
What does Investment Diversification mean?
Investment diversification is a considered and measured plan to mitigate risk across your investment portfolio. It may smooth returns over the long term.
“Don’t put all your eggs in one basket.”
Financial markets are always going to be subject to varying levels of volatility. Share prices can be affected by consumer perceptions and confidence, and particular markets and sectors may experience volatility at different times. Market performance may also reflect a reaction to economic, legislative, and corporate factors.
There is an inherent risk in every investment – some are just not as obvious as others. For example, if you choose low-risk investments such as cash or other defensive assets, portfolios may be at risk of a return that doesn’t keep up with inflation. Conversely, high-risk assets often bring a greater chance of volatility.
Diversification allows you to spread the risk across growth and defensive assets and helps to reduce the risk of concentrated losses. It’s a way of balancing out the highs and lows that can occur.
Depending on your overall investment strategy, you may look to diversify within an:
- asset class – cash, shares, property, fixed interest, etc.,
- market – local or global assets, or
Or it may be appropriate to diversify across all three areas.
A priority when considering diversification is to set up your portfolio in a way that will allow you to meet your financial goals while balancing the risk of your investments.
Mitigate Risk with Investment Diversification
At times we see significant swings in share prices, both positive and negative. Where one company may have experienced unparalleled gains, another company may be having a year of negative growth in their share price.
What Factors can Affect a Share Price?
- Company announcements (These can have a positive or negative effect depending on the news)
- Interest rates
- Government legislation or policy
- Exchange rates
- Commodity prices
- Natural disasters
- News & media
- Consumer confidence
- International financial markets and economies
These factors are also key considerations when developing a strategy for investment diversification that addresses risk mitigation.
However, it’s important to remember that the share price doesn’t always reflect the underlying quality of the company. Therefore, investment choices shouldn’t be made based on an attractive share price in isolation.
Consider Dividends in Your Investment Portfolio
Another avenue of diversification that is often overlooked is dividends. Dividends is one way you may receive a regular return on investments, and they may also provide a ‘safety net’ in down-trending markets when part of a diverse portfolio. It pays to remember that capital growth isn’t the only way to measure return on your investment. Always factor in dividends when calculating portfolio returns.
As mentioned above, a share price and its daily fluctuations are a result of many different factors. Dividends are calculated based on company performance and this means they aren’t susceptible to short-term crises within the share market. Dividends paid by quality companies shouldn’t vary by much each year and may offer a regular source of income when interest rates are low. There are other investments you can also consider when income returns are important in an investment portfolio. If income isn’t a priority, reinvesting returns may also provide a boost to total returns, in rising markets, over the long term.
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IMPORTANT INFORMATION: This blog has been prepared by Modoras Pty. Ltd. ABN 86 068 034 908 an Australian Financial Services and Credit Licences (Number 233209). The information and opinions contained in this presentation is general information only and is not intended to represent specific personal advice (Accounting, taxation, financial, insurance or credit). No individuals’ personal circumstances have been taken into consideration for the preparation of this material. Any individual making any investment or borrowing decisions should make their own assessment taking into account their own particular circumstances. The information and opinions herein do not constitute any recommendation to borrow funds or purchase, sell or hold any particular investment. Modoras Pty Ltd recommends that no financial product or financial service be acquired or disposed of, credit contract entered into or financial strategy adopted without you first obtaining professional personal financial advice suitable and appropriate to your own personal needs, objectives, goals and circumstances. Information, forecasts and opinions contained in this blog may change without notice. Modoras Pty. Ltd. does not guarantee the accuracy of the information at any particular time. Although care has been exercised in compiling the information contained within, Modoras Pty. Ltd. does not warrant that the articles within are free from errors, inaccuracies or omissions. To the extent permissible by law, neither Modoras Pty. Ltd. nor its employees, representatives or agents (including associated and affiliated companies) accept liability for loss or damages incurred as a result of a person acting in reliance of this publication.