Demystifying diversification for Southern Highlands investors

The term ‘diversification’ gets thrown around a lot in financial circles. But most everyday Aussies have never sat down to think about exactly what it means and how it affects their money.

In financial terms, diversification means spreading your money across a range of different investments. Instead of putting all your money in one place where it may be vulnerable to excessive risk, you work with a financial advisor to invest in a range of different assets – whether that’s a savings account, real estate, bonds, or the stock market.

Why diversification is a smart idea for most investors

Famous billionaire, businessman, and investor Warren Buffet once said, “Diversification is protection against ignorance.” What did he mean?

Let’s say you find an incredible investment property locally in Bowral. If you know with 100% certainty that this property will double, triple, or quadruple in value in a short space of time, you will put all your money into it and reap the rewards.

But of course, you don’t know for sure. The property may lose money, either due to factors outside your control, or because you made an error of judgment (it happens to the best of us).

Spreading your money across different investments ensures you won’t lose it all if one investment goes bad. That’s why diversification is a smart risk management tool to protect your wealth against investment uncertainty. 

You can check out this article to learn more about the benefits of a diversified investment portfolio.

Four asset classes to consider for a well-diversified portfolio

Many well-balanced investment portfolios include a mix of these four asset classes:

1.     Cash or cash equivalents

Cash is the simplest asset class to understand because almost every Australian owns it. Transaction accounts, savings accounts, and term deposits are all cash assets. These are typically safe investments (deposits up to $250,000 are guaranteed by the government), but they offer a low rate of return.

Given cash is liquid so you can access it quickly, it’s best used for short-term financial obligations or in case of an emergency. People with lower-risk profiles, such as retirees or pre-retirees, may choose to hold more cash than higher-risk assets (which we’ll cover in a moment).

2.     Bonds

Bonds are essentially loans you make to the government, through a government bond, or to a corporation, using a corporate bond. The loanee pays the loan back to you over time along with regular interest payments.

Bonds are generally considered low-risk investments. One of their main benefits is that they offer a steady income stream, which makes them a popular choice for people who need cash flow in retirement.

3.     Real estate

Investing in real estate involves buying an investment property or a share of a real estate investment trust (REIT). Real estate has long been a favourite of Aussie investors because it provides immediate cash flow through rental income, as well as the potential for capital growth and unique tax benefits. Plus, unlike stocks or bonds, real estate is a tangible asset you can physically manage, which may help you feel safer and more secure with your investment.

4.     Stocks

Stocks, or ‘shares’ as we often call them in Australia, allow you to purchase a small stake in a company. If the company does well financially, the value of your share will increase, or the company will pay you part of their profits in the form of a dividend.

Stocks are considered a high-risk asset compared to cash and bonds. For example, if you look at the Australian Securities Exchange (ASX) since 1900, the local share market has dropped roughly two out of every 10 years. However, it has increased in value the other 80% of the time, with average returns of around 13% per year. If you can afford to invest for the long term and ride out the negative years, the stock market can be an extremely powerful wealth creation method.

Top tips for portfolio diversification

Spread your wealth

As well as spreading your wealth across multiple assets, you can consider diversifying within each investment. For example, if you want to allocate 50% of your investments to stocks, you could diversify across a range of different industries and companies or buy an index fund, instead of placing all your money into one stock.

There are also certain investment vehicles, such as managed funds and investment bonds, that allow you to invest in multiple asset classes in one place. These are very popular among investors who want a simple and tax-effective way of diversifying their portfolios.

Understand your risk profile

Generally speaking, the closer you are to retirement, the lower your tolerance to risk. This is because you have fewer years left in the workforce and your investments have fewer years to recover from a drop in value.

One popular rule of thumb is to take your age in years and use that to determine the percentage of low-risk assets in your portfolio. For example, a 40-year-old sparky from the Southern Highlands might have 40% of their wealth in cash or bonds, with the other 70% in the stock market or a REIT.

Of course, this is just a general rule of thumb, and it’s better to get an individual analysis of your risk profile by speaking to a qualified financial advisor.

Rebalance your portfolio regularly

While it is a proven wealth creation strategy, diversification is not as simple as ‘set and forget’. You should review your risk profile and how your money is invested as your circumstances change. There are a range of life events that may impact your financial situation and goals, such as:

• changing your job or income
• having kids
• divorce or separation
• retiring, or getting closer to retirement
• major purchases, such as a new home
• changes in laws or tax regulations
  
  

Speak to Poole Advisory about diversifying your portfolio today

If most of your money is currently in one asset class, you could be facing an unreasonable level of financial risk. Even if you hold a large portion of your portfolio in cash, you run the risk of losing real wealth over time due to inflation (you can read about how inflation impacts your savings and investments here).

Poole Advisory can help you create a smart diversification strategy according to your risk profile. We provide financial advice on cash assets, bonds, real estate, and stocks to help you build a portfolio to achieve your financial goals.

For more than two decades, we’ve worked with clients in Bowral, the Southern Highlands and Sydney to help them grow and protect their wealth. You can speak to Anthony Poole, our Principal Financial Advisor, by booking a meeting in his calendar here. Otherwise, feel free to send us a message and a friendly member of our team will be in touch as soon as possible.

Compliance Disclaimer:

This information contains general advice only, that is, advice which does not take into account your needs, objectives, or financial situation. You need to consider the appropriateness of that general advice in light of your personal circumstances before acting on the advice. You should obtain and consider the Product Disclosure Statement for any product discussed before making a decision to acquire that product. You should obtain financial or credit advice that addresses your specific needs and situation before making investment or borrowing decisions. Taxation information is based on our interpretation of the relevant laws as at 1 July 2018. While every care has been taken in the preparation of this information, Prosperitas Partners Pty Ltd does not guarantee the accuracy or completeness of the information. The case studies are hypothetical, for illustration purposes only and are not based on actual returns

Poole Advisory Pty Ltd ABN 15 642 040 604 is a Corporate Authorised Representative (No. 001282603) of Prosperitas Partners Pty Ltd ABN 30 662 654 453 AFSL 544 917