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When it comes to investing, one of the best things you can do to reduce risk and improve returns is to diversify your portfolio.
Diversification might sound like a fancy finance phrase, but it’s really just the process of spreading your investments across a variety of assets – or simply, not putting all investment “eggs in one basket”.
Every investment carries risks and is subject to potential unforeseen changes. No investment, not even government bonds or bank deposits, is ever completely safe and guaranteed. If your portfolio is narrowly invested 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 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. Over the longer term, the entire portfolio will be expected to yield higher and less volatile average returns.
A good recent example of this is BHP Billiton. As one of the largest mining companies in the world, it has long been considered a solid and safe “blue-chip” share investment. However, as we have seen in recent months, even an investment in a company as large and profitable as BHP can be highly volatile. In the wake of its Brazilian tailings dam disaster in November last year, BHP’s share price has fallen about 30%! Over the same timeframe (including one of the worst periods of equity market performance for many years), a more diversified portfolio spread across multiple asset classes and geographies (such as our Six Park Balanced Portfolio) would have lost less than 5% of its value.
This is a useful demonstration of the potential pitfalls of investing your money in just a few assets. It also shows how a well-diversified portfolio can help reduce the risk and impact of any one particular investment going “wrong”.
Diversification is a key element of our investment philosophy at Six Park. Our model portfolios utilise a range of carefully selected exchange traded funds (ETFs) to deliver investors highly diversified portfolio holdings. 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.
At Six Park, we never recommend that you put your eggs in one basket. Unless of course those eggs are chocolate – and you’re willing to share one or two with us.