A two-minute guide to diversification and the benefits of it
Schroders produces a wall poster each year that shows the relative performance of all asset classes from the past 20 years. In this article, we explore the benefits of diversification and the role it plays in portfolio construction.
Often people are put off investing money in financial markets for fear of losing money. And the truth is, people can lose money from investing. Of course, there’s the ‘safe’ option of the trusty savings account which can provide a return, albeit a meagre one because interest rates are low. However, in the current climate, inflation could eat away at the value of your savings. Investing, which does come with risk, offers the potential of higher returns.
The benefits of diversification
Experienced investors take steps to mitigate risks. They call it diversification, which basically means spreading your money around.
For instance, while Australian equities returned an average of 8.4% per year between 2000 and 2019 it hides the fact they fell to -38.4% at the height of the financial crisis in 2008. if you had invested all your money in stocks in 2007. You would have lost almost half your money by the end of the following year.
However, if you had invested some of your money in Australian fixed income, some of those losses could have been offset, because bonds rose to 14.9% in the same year.
Diversification doesn’t guarantee you won’t lose money but it should smooth the highs and lows and help avoid the emotional rollercoaster ride.
It also helps you retain access to the money you need: In times of stress the ease in which you can buy and sell an asset is critical. This varies between assets, and is known as liquidity. For instance, property can be more illiquid than equities. Diversification can help.
Too much diversification?
Investing in too many different assets can leave you swimming in confusion.
There is no fixed rule as to how many assets a diversified portfolio should hold: too few can add risk, but so can holding too many. Hundreds of holdings across many different assets can be hard to manage, and diversification for the sake of it runs the risk of poorer performance, sometimes called “diworsification”.
If you are unsure as to the suitability of your investment, speak to a financial adviser, and remember the value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.
Important Information:
This document is issued by Schroder Investment Management Australia Limited (ABN 22 000 443 274, AFSL 226473) (Schroders). It is intended solely for wholesale clients (as defined under the Corporations Act 2001 (Cth)) and is not suitable for distribution to retail clients. This document does not contain and should not be taken as containing any financial product advice or financial product recommendations. This document does not take into consideration any recipient’s objectives, financial situation or needs. Before making any decision relating to a Schroders fund, you should obtain and read a copy of the product disclosure statement available at www.schroders.com.au or other relevant disclosure document for that fund and consider the appropriateness of the fund to your objectives, financial situation and needs. You should also refer to the target market determination for the fund at www.schroders.com.au. All investments carry risk, and the repayment of capital and performance in any of the funds named in this document are not guaranteed by Schroders or any company in the Schroders Group. The material contained in this document is not intended to provide, and should not be relied on for accounting, legal or tax advice. Schroders does not give any warranty as to the accuracy, reliability or completeness of information which is contained in this document. To the maximum extent permitted by law, Schroders, every company in the Schroders plc group, and their respective directors, officers, employees, consultants and agents exclude all liability (however arising) for any direct or indirect loss or damage that may be suffered by the recipient or any other person in connection with this document. Opinions, estimates and projections contained in this document reflect the opinions of the authors as at the date of this document and are subject to change without notice. “Forward-looking” information, such as forecasts or projections, are not guarantees of any future performance and there is no assurance that any forecast or projection will be realised. Past performance is not a reliable indicator of future performance. All references to securities, sectors, regions and/or countries are made for illustrative purposes only and are not to be construed as recommendations to buy, sell or hold. Telephone calls and other electronic communications with Schroders representatives may be recorded.