What is diversification?

You may have heard financial experts speak of diversifying your investments. But what does it mean, and how do you do it?

What is diversification?

Diversifying your investment portfolio means investing in a range of different types, across a range of different risk levels. All investments come with risk - the chance you could not achieve your goals, including losing money. But by spreading your money out - not having all your eggs in one basket - you reduce the risk of not achieving your goals and losing your money. If one investment is disappointing, another might do well.

One example is if you have all your money invested in one company. If the company goes out of business, you could lose all your money you invested and your investment goal will fail. But if you’re invested across a few different types of companies, it’s unlikely they will all go out of business at the same time. You stay on track for your goal.

Diversify across a range of assets and risk levels

Diversifying across different asset classes and risk levels helps reduce your risk. For example, you might have a percentage of ‘growth’, or riskier, investments, like shares or property (called asset classes). You might complement it with lower-risk investments, like bonds, or term deposits. All of these investments together make up an investment portfolio. You can do it yourself or you can use an investment manager with a pre-packaged fund of lower or higher-risk investments.

Risk levels are based on the time you’ll be invested, and how confident and comfortable you are with investing. For example, a portfolio made up mainly of shares will be a growth, higher risk investment, and best for those with a high tolerance for risk, or those investing for 10 years or more.

You can also diversify within shares. Invest in a range of companies (or funds) across different industries and countries to help reduce your risk.

Risk is also based on how easy it is to get your money back. As you know, it’s not easy to get money out of your KiwiSaver account. And some investments have a long withdrawal period -maybe three months. So you might want to invest in something because you can get your money back more quickly – for emergencies, for example.

The impact of Covid-19

Diversification is essential during a crisis. The Covid-19 pandemic is a good example of this. Shares dropped in value during this time. Let’s say the money in shares was the only spare money you had and the value dropped overnight. Then you lost your job and needed cash immediately - you’d potentially have to sell your shares at a much lower value.

But if you had some money in a bank savings account, its value will not have reduced (it may not have increased by much, either). So you could use this first, while you wait for your shares to rebound in value.

Covid-19 is also a good example of why it’s good to diversify your cash. You may have some locked up in term deposits. But it’s always good to have some money in a bank account too, that you can access overnight or the same week for an emergency.

In summary.... 

Diversifying your money and investments across a wide range of asset classes and risk levels can help reduce the risk that can come with investing.

Published 28 May 2020

Pie Funds Management Limited is the issuer of the JUNO KiwiSaver Scheme. You can read our Product Disclosure Statement. This article is general in nature only and has not taken into account any particular person’s objectives or circumstances. We recommend you speak with an independent financial adviser. All content is correct at time of publication date.