A two-minute guide to diversification and the benefits of it
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.
- Responding to COVID19 - Investing in turbulent times
- Will coronavirus cause a recession?
- Perspective in turbulent times - Australian Equities
- Perspective in turbulent times - Multi-Asset
- Perspective in turbulent times - Fixed Income
- Do I need to be worried about coronavirus? How investors can respond to stock market shocks
This material has been issued by Schroder Investment Management Australia Limited (ABN 22 000 443 274, AFSL 226473) (Schroders) for information purposes only. It is intended solely for professional investors and financial advisers and is not suitable for distribution to retail clients. The views and opinions contained herein are those of the authors as at the date of publication and are subject to change due to market and other conditions. Such views and opinions may not necessarily represent those expressed or reflected in other Schroders communications, strategies or funds. The information contained is general information only and does not take into account your objectives, financial situation or needs. Schroders does not give any warranty as to the accuracy, reliability or completeness of information which is contained in this material. Except insofar as liability under any statute cannot be excluded, Schroders and its directors, employees, consultants or any company in the Schroders Group do not accept any liability (whether arising in contract, in tort or negligence or otherwise) for any error or omission in this material or for any resulting loss or damage (whether direct, indirect, consequential or otherwise) suffered by the recipient of this material or any other person. This material is not intended to provide, and should not be relied on for, accounting, legal or tax advice. Any references to securities, sectors, regions and/or countries are for illustrative purposes only. You should note that past performance is not a reliable indicator of future performance. Schroders may record and monitor telephone calls for security, training and compliance purposes. st