The benefits of diversification
The old adage “don’t put all your eggs in one basket” is especially relevant in the context of investments. Relying on too narrow a base of investments is a sure way to increase the risk in your portfolio.
The benefits of diversification
Life is unpredictable, and the only certainty is change. This rule applies to markets as much as any other sphere of life. As Mark Twain said, “Prediction is difficult – particularly when it involves the future.” Following on from our article in September’s quarterly report on the inclusion of a new asset class into our portfolios (global infrastructure), it seems opportune to discuss the benefits of asset class diversification. A set of model portfolios can have very different asset allocations yet be appropriate for different investor cohorts depending on their needs, sensitivities, and risk tolerances.
More chocolate chips, less sugar? Large eggs or small eggs? Wheat flour or almond meal? There are all sorts of recipes for chocolate chip biscuits which result in a satisfactory morning tea. Your investment portfolio can be thought of in a similar way. More bonds, less equity? Large cap stocks or small caps? Real estate or infrastructure? A considered mix of investments should yield a good return and it is this mix, or diversification, that is important.
How do we diversify? By geography, by asset class, for example equities or bonds, by size of company, by type of company, in other words, by ensuring we have breadth in our investments. Once the underlying diversification has been settled upon, an overlay of asset allocation according to an individual’s needs and risk tolerance must be decided upon. The split between growth and defensive assets in a portfolio is likely to be very different for a young couple starting their working life and someone approaching retirement.
Most market forecasters, even if they are right about the market in their predictions one year, cannot replicate their success consistently over time. Creating a balanced portfolio that meets an individual’s needs with regard to cash flow and risk tolerance is the best way to make sure your money is put to work for you for the long-term.
