Spread your money, reduce risk

The latest investor study by the Australian Securities Exchange (ASX) found 40% of investors admit they don’t have a diversified portfolio. Almost one in two investors think their portfolio is diverse, yet they hold, on average, less than three different investment products. 

The role of diversification
Diversification plays a key role in long term investing. To understand why, it can help to think about what goes on at the racetrack, where the bookies always seem to win while the punters are invariably left empty-handed. 

The secret to bookmakers’ success is that they spread their risk by continually changing the odds to encourage punters to back as many different horses in a single race as possible. This spread of money means the wins should outweigh losses. 

Punters, on the other hand, concentrate risk by betting on just one horse in each race. Unless the horse wins, the punter loses his money. 

When it comes to investing, the strategy of spreading your money so you have a little in a broad number of investments, not a lot in one, can strengthen long term returns and minimise losses in much the same way that bookies hedge their bets. 

Sticking to what we know

However, a wealth of research shows diversification is a weak spot for many investors. The ASX found we tend to stick to cash, property and Australian shares. In addition to concentrating risk, this can mean missing out on decent returns earned by other asset classes. 

As a guide, a recent ASX/Russell report found residential property topped the league table of returns for mainstream investments over the last 10 years, averaging gains of 8.1% annually. What’s surprising is that over the same period, global bonds (hedged) and Australian bonds were the next best performing investments with average annual returns of 7.4% and 6.1% respectively. 

Aussie shares didn’t even make the top four, earning an average of 4.3% annually over the past decade (though to be fair, this period includes the global downturn when sharemarkets tanked). Cash delivered woeful returns of just 2.8% annually over the 10-year period. 

Expanding your portfolio

It’s a compelling argument to consider expanding your portfolio beyond the mainstays of cash, bricks and mortar and local shares. 

This is an area where your adviser can deliver tailored recommendations. However, investments like bonds, infrastructure (which incidentally returned 13.3% globally over the last year), or international shares (10.6%) can be good additions to a portfolio. 

These types of investments can be difficult to access as an individual investor, and a managed investment fund – either listed or unlisted, offers an easy way to expand your portfolio into new areas and reap the rewards of diversification. It’s worthwhile seeking advice about what could work best for your portfolio. 

by Paul Clitheroe AM 
Paul Clitheroe AM, co-founder and Executive Director of ipac securities limited, Chairman of the Australian Government Financial Literacy Board and Chief Commentator for Money magazine. 

First published September 2017