If you’re an investor (or considering becoming one), some essentials are important to know, and of these, few are more important than diversification. Diversification is a way of spreading risk associated with investments, or more simply, not putting all your eggs into one basket.
And while diversification is an investment fundamental, it’s when markets become stressed, such as during the current COVID-19 pandemic, where understanding it, becomes valuable.
Why diversification is important
Diversification is important because not all investment types provide the same investment returns at the same time. For example, one type of investment might be producing strong returns while another is performing poorly. Having a diversified investment portfolio can help to smooth out these peaks and troughs, with the aim to hopefully generate more consistent investment returns.
Even during a time of major economic upheaval, when the returns produced by all investment types are affected, having a diversified investment portfolio could help to limit your losses as not all investments will experience the same falls.
Types of investments
Aside from shares and property, other potential types of investment include cash (in the form of term deposits) and fixed interest (bonds issued by governments or companies). They all carry different levels of investment returns, with generally, higher risk investments offering higher returns compared to lower risk investments.
How to diversify your investments
It’s important to remember there are risks attached to investing as returns aren’t guaranteed. You could make money, break even, or even lose money should your investment decrease in value. When doing your research keep in mind past performance is not a reliable indicator of future performance.
One of the simplest ways of diversifying your investments is by investing in several different asset classes rather than just one, if you’re financially able to do so. For example, buying shares, an investment property and investing some money into a term deposit.
You could diversify your share portfolio by buying shares in different companies that operate in different sectors and locations. Or invest in exchange-traded funds (EFTs), which are a mixed group of shares that make up an index, such as ASX200.
Investing in a downturn
If you’re thinking about taking advantage of the current market downturn to start or expand your investment portfolio, remember that while lower asset prices do create opportunities for increased returns, the economic uncertainty also means that prices could fall further. Before taking any action there are several things you should consider, including:
• how much you can afford to invest
• your risk appetite
• your investment timeframe
• how you’ll diversify your investments.
One option is to enter the investment markets gradually, for example by investing a certain amount each week, fortnight or month to help diversify against the risk that assets prices fall further.
Contact us if you would like to review your investment portfolio or if you are thinking of investing at this time and we can help you to maintain the appropriate level of diversification.
© AMP Life Limited, First published May 2020