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How to diversify your portfolio
Diversification can mean lower risk without sacrificing returns.
Key takeaways
- Diversifying your portfolio can protect you from over-exposure and provide more stable returns.
- Diversification means investing in a variety of assets and asset classes.
- ETFs are the easiest way to diversify your stock portfolio.
4 easy ways to diversify portfolio
- Invest your money in 10+ stocks, or buy an exchange-traded fund (ETF).
- Keep a portion of your money into fixed assets such as a savings account, term deposit or bonds.
- Consider international stocks or investments.
- Balance your portfolio across assets with different risk profiles.
Finder survey: Do Australians of different ages have an investment plan?
| Response | |
|---|---|
| No | 75.63% |
| Yes | 24.37% |
Source: Finder survey by Pure Profile of 1145 Australians, December 2023
What is a diversified portfolio?
A diversified portfolio will be one that has multiple types of investments, rather than investing in a single asset or asset class.
For example, if you have all your money sitting in a savings account, you don't have a diversified portfolio.
Similarly, a property investor who owns numerous investment properties but doesn't have any other investments, doesn’t have a diversified investment portfolio.
While they may have a diversified property portfolio (if they invest in a range of different property types such as houses, apartments and land), they can't really be considered to be a diversified investor.
This is because they are only investing in a single asset class (in this case property).
What is an example of a diversified portfolio?
Say an Australian investor has $200,000 in capital that they want to use to build a diversified portfolio. They might approach it in the following way.
- 20% in 10+ Australian dividend stocks (mining, banking) or an ASX ETF
- 20% in a high interest savings account
- 30% for a deposit for an investment property
- 20% in an ETF that tracks the S&P 500, Nasdaq-100 or other leading US stock index
- 10% in higher risk assets of their choice (for example, individual growth stocks or cryptocurrency)
Please note, this example is for illustrative purposes only and shouldn't be used to inform your own investment decisions.
This hypothetical portfolio would be invested across 3-4 asset classes that offer different risk profiles, and also is not exclusively exposed to the Australian economy.
The benefits of a diversified portfolio
The main benefit is that it minimises risk.
It's a "don't put all your eggs in one basket" approach to investing.
This is because in the unfortunate event that something were to happen to that basket, all your eggs – or money – would be gone.
If an investment class performs poorly over a certain period you will only lose money on your investments in that asset, rather than across your whole portfolio.
Let's say you only invested in shares in Australian companies.
Each time the Australian market fluctuates your entire investment portfolio would be affected. But, if only one-quarter of your portfolio was in shares then only one-quarter of your portfolio would be affected.
It's also of benefit to diversify your portfolio within particular asset classes. For example, if you’re investing in shares, investing in a range of different sectors and industries will further help minimise risk to your investment portfolio as a whole.
How do I know if my portfolio is diversified?
1. You aren’t concerned by short-term performance
If your money is properly diversified, you generally aren’t concerned about what the market does on any particular day.
If small market fluctuations are keeping you up at night, this could be a sign that you have too much money invested in a particular asset class.
2. You’re in it for the long term
Investors with diversified portfolios are generally in it for the long term and are investing to create future wealth.
Non-diverse investors tend to invest a large pool of money into an asset for a short amount of time.
If you’re investing with the intention to sit tight for the next 20, 30 or 40 years, you will likely have a diversified portfolio.
3. You ignore trends and market hype
Investors who don’t have a properly diversified portfolio are likely to get caught up chasing the next big investment opportunity. They might keep an eye out for shares that are underpriced with the intention to buy and sell and make a quick buck.
Diversified investors are usually more confident because they have a stable, well planned, long-term strategy.
4. Your money is invested in a variety of the traditional asset classes
The more asset classes you’re invested in, the more diversified your portfolio is, meaning it's also lower risk. If you have money invested in 2 or more of these asset classes, you have a diversified portfolio:
- Cash. This includes term deposits, savings accounts and cheque accounts.
- Australian shares. Also referred to as equities, share trading is the partial ownership of a publicly listed Australian company, such as one of the major banks. These are traded on the Australian Stock Exchange (ASX) and you can earn a portion of the company’s profits in the form of dividends.
- Global shares. This includes direct ownership of US, Asian and European stocks or simply using an ASX-traded ETF that tracks the performance of a foreign stock market.
- Property. This includes direct ownership of residential or commercial property. It can also include partial ownership of property through a managed fund or Australian real estate investment trusts (A-REITs).
- Commodities. This includes natural resources such as coal, copper and iron ore and precious metals such as gold and silver.
- Bonds. Bonds are a form of tradable loan that can be bought and sold in a similar way as shares. Bonds are loans made to a government entity with investors earning money out of the interest payments on the loan.
5. You invest in exchange-traded funds (ETFs)
An ETF is a type of managed fund that is traded on the ASX like shares. The fund owns a range of assets including local and global shares, bonds, foreign currencies and commodities. The investor doesn't own these underlying assets but instead owns a portion of the entire ETF. So even if you only invest in ETFs, you automatically have a diversified portfolio.
VIDEO: How to track your portfolio
How to identify gaps in your portfolio
For many investors, it could be tempting to put your money into 1 or 2 assets, especially if they are continuing to gain market share.
But if the price of that asset falls so does your overall wealth. Especially if they are in the same asset class.
Take for example owning shares in 2 of Australia's Big Four banks.
While an investor might say they own 2 different assets, they are likely to be impacted in the same way.
To diversify, an investor could put their money in a number of different stocks in a variety of asset classes.
In order to find out if your share portfolio is diversified you could look at whether or not your holdings are all in the same asset class.
There are 11 ASX categories: energy, materials, industrials, consumer discretionary, consumer staples, health care, financials, information technology, communication services, utilities and real estate.
If an investor wants to make sure they are diversified through shares they don't necessarily need to have assets in all of these categories but being in more than 1 or 2 can help.
The second option for investors is to put their money into other asset classes or even international shares. This can help offset potential issues in the Australian share market.
Can you over-diversify your portfolio?
Yes it's theoretically possible for you to over-diversify, which will limit your upside.
Basically, if adding a new investment in your portfolio increases your portfolio's overall risk or lowers expected returns without the benefit of lowering risks, then it does not really serve your overall financial goals.
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