Article

Should my investment option include a diversified mix of investments?

Super and investments 101 | Date Posted: 21 November 2019

 

“The beauty of diversification is it’s about as close as you can get to a free lunch in investing.” - Barry Ritholtz, US investment manager and Bloomberg commentator

For most people, the answer is ‘yes’.

For most people, their super is often their most valuable asset, with the possible exceptions of their future income and their home. When it comes to super, it’s important to diversify your investments, so you’re not putting all your eggs in one basket.

What is diversification?

By diversification we mean spreading your investments across a mix of asset classes, such as shares, property, bonds or cash. Diversification works because positive returns of some investments can make up for negative returns of others.

How much you invest in each asset class depends on your investment time frame, risk tolerance and investment goals. We’ll talk more about this in future editions.

As an example in the mining industry, a company with a diversified portfolio of mine sites, perhaps recovering a mix of minerals, may be better able to deliver stable profits to investors over the long-term than a company that owns a single mine site. The single mine site could make a great return over a short-term, however if it finds that mineable reserves are less valuable than expected, it encounters unforeseen geological challenges or it suffers a falling commodity price, then shareholders may lose out.

Smoothing life’s ups and downs

A diversified investment option is made up of a wide mix of investments that will each generate different returns, which will vary depending on the economic circumstances.

This will have the effect of reducing volatility over time – or in other words, smoothing the ups and downs of investment markets.

Balancing risk and return

When investing your super, you need to consider balancing long-term financial goals against your willingness to live with the risk of losing money, especially over the shorter-term. The general rule is that as the potential for a higher return increases, the risk of loss also becomes greater.

This is known as the 'risk/return relationship’. When choosing where to invest your super you need to strike a balance between the risk you’re comfortable with and the rate of return you need to achieve your retirement goal.

This means that you should consider investing in growth assets, such as equities (shares in companies), as well as defensive assets, such as bonds (debt securities issued by governments and companies) or cash.

At different times in the economic cycle, either growth assets or defensive assets may outperform the other. It is unusual for both types of investments to lose money simultaneously over an extended period of time.

Summary

Diversifying your investments won’t ensure a particular level of income when you retire or prevent your super losing money over a particular period of time. However, it can help maximise your chances of holding investments that deliver decent long-term returns. 

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