Diversification is a basic principle of prudent financial management. The old adage of “don’t put all your eggs in one basket” has proven to be true in the light of history. There are three basic forms of diversification that you should be aware of in selecting your investment options:

Diversification across asset classes

Investments can be placed in the four major asset classes: shares, property, fixed interest (such as term deposits and bonds) and cash. When you spread your investments across these areas, you are able to take advantage of upturns in one asset class while avoiding over exposure to any one area during periods of poor performance.

Cash and fixed interest investments generally provide a highly certain level of income and preservation of capital. These are generally called defensive asset investments for this reason. The performance of these asset classes over time however, has historically not been as high as the other asset classes.

Shares are able to generate higher returns in the long term, but their performance from year to year can be volatile. Property has historically provided returns somewhere in the middle - not as volatile as shares but with better returns than cash and fixed interest. Shares and property investments are generally called growth or aggressive asset investments.

For most investors, some exposure to all four asset classes is appropriate. The area that is emphasised is determined by the likely period of time the investment will be held, the investor’s particular income and growth needs, and the amount of volatility an investor can tolerate.

Whilst shares and property are riskier than cash and fixed interest in the short term, they should provide greater protection against inflation in the longer term due to the prospect of income growth and therefore capital growth.

Diversification within asset classes

Investments within any asset class can be diversified by geographic location, industry, and the nature of the security itself. For example, when investing in shares it is prudent to recognise that the Australian share market is barely 2% of the world market and for this reason share investments without any exposure to international holdings constitutes a higher non-diversified risk. A diversified share portfolio would generally include a minimum of 20 stocks with exposure to different size companies and different sectors; e.g. banking, resources, industrials, etc.

Diversification across investment management styles

Different fund managers have varying investment styles and perform differently during changing economic conditions of the investment cycle. For this reason, more than one fund manager is normally recommended to provide diversification for portfolios of greater than $50,000. Diversification is important not only across asset classes but across funds themselves.

For information on managers’ investment styles contact ACS Financial on 1800 646 777.

Get financial advice

This section is not intended to provide you with personal financial advice and is to be used as a general guide only.  Naturally, everyone’s personal retirement goals will be different, so it is important you choose an investment option that suits your needs. We recommend that prior to selecting an investment option you seek financial advice that is tailored to your particular circumstances.