Diversification – The Only Free Lunch in Investing

When it comes to portfolio construction no single asset class will consistently outperform all other assets all the time.

To minimise potential losses and smooth investment returns over the long term, you should spread your portfolio across various investments.

This is easier said than done as there are many ways to diversify.

Diversify across asset classes

Asset classes are the broad categories of investments and include equities, fixed interest, property, and cash investments.

Equities include both Australian and international shares. Fixed interest includes government, semi-government and corporate bonds.

Property includes residential, retail, and commercial properties. Cash includes term deposits and at-call cash accounts. 

Lower risk asset classes, including fixed interest and cash, protect your capital during adverse market conditions.

On the other hand, higher risk assets such as Australian and international shares, can deliver strong returns during the boom times.

Holding a mix of asset classes may help to provide more stable returns over the medium to long term as markets rise and fall. 

Diversify within asset classes

This could mean spreading your share portfolio across different industry sectors because certain sectors may outperform others over a given period according to economic conditions.

Two good examples are mining and manufacturing. The Australian resources industry helped keep Australia’s economy a shining light against a gloomy international backdrop following the Global Financial Crisis.

Manufacturing, on the other hand, struggles with high labour costs making Australia less competitive against low income countries such as China.

Nobody knows what the future holds - both of these industries are facing volatile conditions a few short years later - so a balance across industries is crucial.

It can be simple

Even with a relatively modest amount to invest and very little time, you can construct a fully diversified portfolio with the right mix of investments.

Managed funds offer easy access to a wide range of investments.

By investing in a managed fund, professional fund managers select individual investments for you.

In addition, most managed funds offer several different options to cater for varied levels of investment risk. 

Other options include purchasing shares in Listed Investment Companies (LICs) and Exchange Traded Funds (ETFs).

Depending on its charter, a LIC holds shares in a wide range of companies, while ETFs invest across all stocks making up a particular index, such as the S&P/ASX 200.

Buying shares in an ETF or LIC gives you exposure to all the stocks held by the fund. 

For more information

Talk to an RSM financial adviser about the best ways to manage your investment risk.   

Note: past performance is not an indicator of future results.

This article has been prepared by RSM Financial Services Australia Pty Ltd ABN 22 009 176 354, AFS Licence No. 238282.

As everyone's circumstances are different and this article doesn't take into account your personal situation, it is important that you consider the above in light of your financial situation, needs and objectives, and seek financial advice before implementing a strategy.

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