Why You Should Diversify

In the world of finance, diversification is the process of allocating capital in a way that reduces the exposure to any one particular asset or risk. This process is designed to help reduce the volatility of your portfolio over time.

The best investment managers in the world agree that, although there’s no guarantee you won’t experience negative returns at times, diversification is the most important factor in achieving long-term financial success while minimising risk.

Let’s look at a simple case study involving my hypothetical client named Ben:

  • Ben is a 30-year-old Engineer looking for a stable long-term return on his investments.
  • He has about $50,000 that he’s hoping to invest into the stock market.
  • He also has a hot tip that the stock in Virgin Australia are about to skyrocket.
  • Knowing that he probably shouldn’t put all his eggs in one basket Ben elects to invest $30,000 into Virgin Australia stocks and diversify his remaining $20,000 into Aurizon.

Has Ben successfully diversified his portfolio?

  • Ben has chosen 2 stocks to invest his money.
  • Both stocks are in the transport industry, because of this both stock picks are affected by many of the same risks.
  • Portfolio analysts would say that air and rail stocks have a very strong correlation. This means that there is a strong likelihood that the two assets would move in sync (i.e. moving up and down at the same time).
  • Ben would have achieved more diversification if he invested across the board, not only different types of companies but also different types of industries.

How would financial planners look at Ben’s portfolio?

  • In the world of financial planning we look towards the correlation of assets.
  • The more negatively correlated Ben’s stocks are, the better.
  • It’s also important that Ben diversifies among different asset classes.
  • Different asset classes are unlikely to perform the same over longer periods of time therefore, a good mix of asset classes will reduce the sensitivity of Ben’s portfolio to market swings.

Ben’s Bottom Line

Firstly, $50,000 isn’t a small amount. Ben could choose to further diversify his funds across different sectors and asset classes. Diversification could help Ben manage risk and reduce the volatility of his portfolio.

Ben can reduce his risk associated with individual stocks, general market risks however affect nearly every stock, and so it is also important to diversify among different asset classes.

Unfortunately, most people don’t have time to manage these risks themselves, so I would encourage anybody starting out investing to seek professional advice on the matter. The benefits of the advice would likely far out-weigh the costs.

We specialise in customising strategic solutions across a range of financial services.

...

Nexus Private Wealth Management is privately owned and not licensed by a bank or institution. We do not sell our own financial products or property.

Wealth Management

1. We get to know your big picture

The first step is for us to understand where you are now and have a clear picture of where you want to be and the things that are important to you.

Wealth Management

2. We create tailored solutions

We prepare well-considered plans that draw on a vast array of financial strategies and practical experience to achieve your objectives.

Wealth Management

3. We implement and manage your plan

Our connected team of specialists take a collaborative approach to ensure superior outcomes now and into the future.

  • If you’ve been discussing your goals and finances, and someone you know is curious, let us know!

    Call us on: 1300 473 347 or share their details below…

  • Your Details

  • Existing Client?

  • Referral Details

  • This field is for validation purposes and should be left unchanged.
  • Free Tax Efficiency Review

    Yes, I want to assess the tax efficiency of my personal finances…

  • This field is for validation purposes and should be left unchanged.
  • Yes, I want to know more about buying property using my super!

  • This field is for validation purposes and should be left unchanged.
Please wait...

Subscribe to our newsletter

Want to be notified when our article is published? Enter your email address and name below to be the first to know.