Are you protecting your long-term wealth with diversification?
According to stats from the CFA Institute, only 21.4 per cent of U.S. stocks beat the market over 20 years from 1927 – 2020, illustrating the utmost importance of diversifying your portfolio and not relying on one ‘golden goose’ to bring you success. But what is diversification, and how can it impact your long-term goals?
Today we’re going to look at what diversification is, the impact of failing to diversify, and your options for a healthy diversified investment portfolio.
What is Diversification?
If you’ve heard the term ‘don’t put all your eggs in one basket’ you’re already halfway there to understanding the principles of diversification. In essence, it means to spread your risk so that if one investment falls, that one fall won’t derail your entire wealth creation strategy. Rather than bundling your investments into a single asset, region or industry, you can diversify your investments over many different types.
Diversifying your portfolio helps stabilise your results whilst improving potential long-term returns. Future returns are always uncertain as markets continue to evolve, so banking on a single investment idea is often never the best approach – or a wise one.
Different investments respond differently to market events. As an example, consider how the tourism industry weathered the pandemic back in 2020. If you had invested solely in the tourism industry, your portfolio may have experienced one bumpy ride (no pun intended). But if that was only a small part of your portfolio, and you had spread your risk across other industries, like e-commerce as an example, your results may have shown a different story.
What are my options for diversification?
While there are many ways to minimise your investment risk, there is no one-size-fits-all approach. Your strategy should be entirely dependent on your unique circumstances and the goals you’re working to achieve. Below are some investment options you could choose from:
- Cash
- Shares
- Bonds
- Property
- Commodities
And you can diversify further by investing across different geographic regions, industries, company sizes, and more. One tactic is to choose asset classes that move in opposite directions to each other. For example, when shares rise, bonds tend to fall and vice versa.
Another approach is to diversify the risk profile of your investments. Asset classes like property and shares can have higher returns over the long-term but may experience volatility in the short term, whilst cash and bonds may have lower returns but tend to perform more steadily. Having a combination of both can help to offset some volatility and smooth out your returns over the long run.
Understanding your diversification approach is also not something you need to figure out alone; some investment options already do the diversification for you. If you invest in managed funds, KiwiSaver, Exchange Traded Funds (ETFs) or index funds, you’re already on the journey to a well-diversified portfolio.
More on Managed funds and ETFs
Managed funds and ETFs work by pooling investor money into a fund, then investing it into a bundle of different assets which are chosen by a fund manager on the behalf of the investor. Managed funds and ETFs can help to simplify investing because the fund manager has done the hard work of researching individual assets and diversified for you.
The key difference between these two investment types is: managed funds can be traded at the end of the trading day on a calculated price, whilst ETFs can only be traded throughout the trading day just like shares. Many managed funds are actively or passively managed by a fund manager, whilst ETFs are mostly passively managed and often created to track market or specific sector indexes. ETFs can be a cost-efficient way to invest because they typically have lower fees than managed funds.
If you’re investing through KiwiSaver, your money is already invested in a managed fund.
What’s the best approach?
The most suitable approach for your situation will depend on your circumstances, your goals, and the time you have left to achieve them. A Wealth Expert at AdviceFirst can work with you to plan the way forward. We work with an array of fund managers who tackle different wealth creation strategies and objectives to suit different investment approaches.
Choosing the appropriate investment vehicle can be overwhelming, but enlisting the support of a Wealth Expert can make it simple:
- Our advisers utilise industry-leading practices tailored to your individual circumstances providing a unique blend of expertise and consideration that is unique to AdviceFirst.
- We aim to align all portfolios within range of a % allocation to various asset classes according to the Strategic Asset Allocations (SAA) for each risk profile.
- The SAA has been developed using the expertise of Blackrock Inc, a multi-national investment company, and is designed to optimise returns while alleviating excessive risk exposure.
Our comprehensive approach allows us to create a customised investment strategy and portfolio designed to help you reach your goals.
Book a financial review
If you’re interested in exploring strategies for your investment portfolio, we invite you to book a financial review with an AdviceFirst Wealth Adviser. Reach out to the AdviceFirst team on 0800 438 238 or email hello@advicefirst.co.nz.
Disclaimer: This blog is for informational purposes only and does not constitute individual financial advice.
