Diversification

It is almost impossible to predict how the financial markets will perform - if we could predict sudden corrections in the share market or changes in the value of the Australian dollar we'd all be millionaires. But diversifying your investments can help you take advantage of the 'ups' while moderating the 'downs'.

Managed funds are a great way to diversify
Managed funds can reduce risk by spreading your money across a number of investments including asset classes, companies, industries, sectors, countries and fund managers.

What is diversification?
Simply put, diversification is not putting all your eggs in one basket. Or not putting all your money into just one type of investment. All investments are subject to some level of risk. Some more than others.

How can diversification help reduce investment risk?
Different types of investments perform better under different market conditions. By investing in more than one type of investment you diversify, which can help reduce the risk for your overall investment portfolio. The more ways you diversify the more likely you are to reduce your risk. For example, across

  • Different asset classes (cash, fixed interest, property, shares)
  • More than one investment in each asset class (eg several different industries and companies when investing in shares)
  • More than one type of fund and investment manager when investing in managed funds.

Let's say you had all your money in just one investment and that investment didn't perform - you would make a loss. But, if you spread your money across different types of investments you may have a better chance of including some investments that will perform.

EXAMPLE:
Simple single investment Value on Average annual return Value on
1 Jan 2000 1 Jan 2005
Shares in Widgets Inc Australia $50,000 - 3% $42,937
TOTAL $50,000 - 3% $42,937

 

Diversified investment portfolio      
  1 Jan 2000 Increase/Decrease 1 Jan 2005
Shares in Widgets Inc Australia $5,000 - 3% pa $4,294
Shares in Widgets International $15,000 + 12% $26,435
Shares in Computing America $10,000 - 2% pa $9,039
Fixed Interest $5,000 + 6% pa $6,691
Property Shares $10,000 +10% pa $16,105
Cash $5,000 + 5% pa $6,381
TOTAL $50,000 + 2.6% AVERAGE $68,946

This example is for illustrative purposes only and does not represent the past or future return of any product or strategy offered by Colonial First State.

How much diversification is enough?
This depends on a number of personal decisions

How long you intend to invest If you were investing for 12 months or less, a financial adviser would probably recommend you keep your money in cash or a term deposit. That way you wouldn’t be subject to possible short term fluctuations. But it would also mean you wouldn’t diversify your investment.
Your risk profile As a general rule, how you diversify your investments has a lot to do with how well you understand the relationship between risk and return and the level of risk and return you’re looking for.
How much money you have to invest If you are investing just a few thousand dollars it may not be cost effective to diversify your money across more than one asset class as the transaction fees may eat up any earnings you make. Managed funds are an effective way to diversify with small and large amounts of money, either as a single investment or as a way of investing ongoing savings.

 

What to consider next

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The information contained in this document is based on the understanding Colonial First State Investments Limited ABN 98 002 348 352 AFS Licence 232468 has of the relevant Australian laws as at 1 July 2009. This document is not advice and is intended to provide general information only. It does not take into account your individual needs, objectives or personal circumstances. You should assess whether the information is appropriate for you and consider talking to a financial adviser before making an investment decision. Product Disclosure Statements (PDS) for products offered by Colonial First State are available from colonialfirststate.com.au or by contacting us on 13 13 36. You should read the relevant PDS and consider whether the product is right for you. Past performance and awards are no indication of future performance.