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SMART MONEY - Separate those eggs
By Jeffrey Lucy
Volume 50, No. 17, September 20, 2007 |
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MIX IT UP: It pays to diversify your investments to protect against changing economic forces and market fluctuations.
Photo: LAC Aaron Curran |
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Facing risks is a part of life, whether they be personal, professional or financial. As a member of the ADF, you are skilled in identifying, assessing and managing risks. The same discipline is needed when dealing with financial risks.
Perhaps the key difference in dealing with risk in the ADF is that diversification is not a viable option, whereas in financial investing it is a key ingredient.
What is it?
Diversification means spreading your investments so you don’t have all your money in one investment, or “all your eggs in one basket”. The aim is to reduce the risk, so that if one investment produces poor results or is wiped out you have other investments that may offset the loss, be that from income or the return on your capital.
True diversification is investing in different types of investments, or “asset classes”, helping to protect against changing economic forces and market fluctuations. The broader you diversify, the lower your risk because no two investments perform exactly the same way at the same time.
There are four main asset classes, or types, of investments:
- cash, e.g. savings account;
- fixed interest, e.g. term deposits, government bonds;
- property, e.g. residential, commercial or a property trust; and
- shares, e.g. Australian Securities Exchange-listed companies.
If you are making your own investment decisions, then diversifying might be putting some money in shares and some in a fixed-term deposit. You might decide to invest in various companies, such as a bank, mining company and a healthcare group.
Other investments already factor in diversification. For example, many managed funds and licensed investment companies give you access to a range of investments suited to the level of risk you are willing to take.
Common mistakes
Some people think they are diversifying if they simply buy multiple investments of the same type. This is not effective as those investments are all likely to be affected in the same way should market conditions change. When diversifying your investments, apply the following:
- don’t spread your money between different companies in the same asset class;
- don’t spread your money between different companies of the same type (for example, companies in different asset classes but in the same business); and
- don’t overlook the impact of economic events. For example, oil price rises can affect companies in quite different lines of business if they rely on oil-based raw materials and can’t recover rising costs.
Effectively spreading your risk may mean investing in different sectors of the economy.
What to do
You or your partner may have a choice of super fund, and you may be able to choose from investment strategies within your super fund (such as a growth-versus-balanced fund). Even within super, you can spread your risks by diversifying.
If you think your investments are too concentrated or you need help structuring your investment portfolio, consider getting professional financial advice from a licensed financial adviser.
This column is an initiative of the ADF Financial Services Consumer Council. Send your questions and comments to ADFcolumn@asic.gov.au. For information about the risks of investing and superannuation, visit ASIC’s website at www.fido.gov.au. |
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