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The importance of diversification in managing an investment portfolio

The Importance Of Diversification

How important is diversification? Diversification is a risk management strategy that involves investing across or within different asset classes to minimise the ups and downs of financial markets. In other words, diversification is about not having all your eggs in one basket. What are asset classes?

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Investments are often divided into asset classes - categories of investments that display similar characteristics and market behaviours. Generally speaking there are four broad asset classes— cash, fixed interest, property and shares.

How does diversification work?

  • A combination of asset classes will reduce your portfolio's sensitivity to market swings;
  • Unfortunately, even the best analysis of a company and its financial statements cannot guarantee that it won't be a losing investment;
  • Why You Should Diversify Let's say you have a portfolio of only airline stocks.

Diversification works by spreading investments across and within different asset classes. Because asset classes have their own unique economic cycles, when one class is making stronger returns, another may not be performing as well.

For example, you might be nearing retirement and looking for a range of investments that will preserve your capital while also providing you with an income.

  1. Because asset classes have their own unique economic cycles, when one class is making stronger returns, another may not be performing as well.
  2. Spreading your investments across the main asset classes by assigning a portion of your portfolio to shares, property, fixed interest and cash Diversify within asset classes, such as investing in shares within different sectors.
  3. Steps Of Effective Diversification What asset class is it? It may only add to your risk.
  4. Delivered twice a week, straight to your inbox. Not in your favor — The marketplace is unpredictable and when this sometimes yields financial loss.
  5. They both help you get the risk-return balance just right for you. It is possible to over-diversify your portfolio.

Strategies for diversifying There are several different ways to create a diversified portfolio. Spreading your investments across the main asset classes by assigning a portion of your portfolio to shares, property, fixed interest and cash Diversify within asset classes, such as investing in shares within different sectors.

How important is diversification?

This would mean ensuring you have a well-balanced share portfolio representing the major sectors such as mining, materials, financials and consumer discretionary. Diversify with a managed investment.

Effective Diversification

This could be a cost-effective means of gaining exposure to a range of different sectors, markets and asset classes within the one investment. You could consider investing into an unlisted managed fund or buying an ETF on the Australian share market.

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Invest in local and international markets. Rather than just having money invested in Australian markets, you could look at overseas markets as well. This is because different markets can operate on their own economic cycles as well.

  1. Rather than just having money invested in Australian markets, you could look at overseas markets as well. And finally, what your investment timescale is.
  2. Different assets - such as bonds and stocks - will not react in the same way to adverse events. The more uncorrelated your stocks are, the better.
  3. You may already be over-weighted to a particular asset class.
  4. A simple example is if, for example, you want to invest in stocks and shares then you would diversify your portfolio by investing in a number of different companies.

A managed fund or investment could be a cost-effective way to gain exposure to international markets. Invest at regular intervals as this can help iron out volatility in share prices and other investments. This is because the market prices tend to fluctuate over time, so making regular investments rather than all at once lessens the likelihood of only adding to your portfolio when prices are high.

You should also consider speaking with a financial adviser.