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The Importance of Diversification

It may seem like an oft-quoted investment cliché, but portfolio diversification – that is, avoiding putting all your investment “eggs in one basket” - is one of the most effective ways to reduce risk, preserve wealth and improve returns.

Every investment carries risks and is subject to potential unforeseen changes. No investment, not even government bonds or bank deposits, is ever completely safe. If your portfolio is narrowly invested (e.g. in a limited number of assets or sectors), then an unexpected change in conditions affecting those assets or sectors could have a drastic impact on your returns. However, if your investment “eggs” are spread across a wide variety of sector and asset “baskets”, each with different characteristics and profiles (i.e. what experts coin “uncorrelated” assets), then the risk of your portfolio being impacted by change will be reduced. This is because the negative performance of some investments will tend to be neutralised by the positive of performance of others – and over the longer term, the entire portfolio will be expected to yield higher and less volatile average returns. Put another way, diversification is a way of “taking a bet each way” with your investments. Since no one really knows what the future will hold, spreading your “bets” across different options (or in this case, investments) enables you to reduce the risk of making the “wrong” decision.

At Six Park, we utilise a range of carefully selected exchange traded funds (ETFs) to deliver investors highly diversified portfolio holdings.(1) Using this approach, your money is invested across literally thousands of companies, sectors, asset classes and positions – instantly and inexpensively delivering you a truly diversified portfolio.

Although we are a proud Australian owned and operated business, we recognise that the Australian share market makes up less than 2% of the world’s total by market capitalisation – and that as such, limiting one’s investment pool to the local market will inevitably limit the investment potential and risk mitigation benefits afforded by the global market. As part of our focus on asset diversification, we ensure our client’s portfolios include appropriate allocations to (Australian-listed) ETFs which invest in international markets and opportunities.

(1) An Exchange Traded Fund (or ETF for short) is an investment fund that can be bought and sold on the share market (like a share). Each ETF holds a pool of underlying assets - such as shares, bonds or commodities - and will typically aim to track a particular market index (e.g. an Australian equities ETF may seek to track the ASX200 index). However, rather than selecting individual investments or specific managed funds, ETFs usually invest broadly within and across their entire index of interest. That is, they literally buy the whole index (or a very close subset) that they seek to track, allocating their funds across every (or almost every) share/bond/asset in the same proportion that those shares/bonds/assets represent of the underlying market. In doing so, ETFs basically mimic the performance of their targeted index - but with low costs and high tax efficiency. Being readily tradeable on the share market, ETFs represent an excellent vehicle to provide investors with a low-cost, highly diversified and immediate exposure to specific target asset classes.

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