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The role of diversification in an investment portfolio

When it comes to managing investment risk, diversification is likely to be a key part of your strategy.

A well-diversified portfolio should provide more stable returns over time.

Here is a rundown of what you need to know.

What is diversification?

Diversification refers to spreading your investment across a range of asset classes and asset types– the financial interpretation of not putting all your eggs in one basket.

This provides a defence against a single investment failing, or an asset class underperforming.

In a well-diversified portfolio, it is generally the case that some assets are performing better than others, reducing volatility and the risk of the entire portfolio falling in value at one time.

Asset diversification

Diversification within asset classes is a common strategy.

If all your money is in the shares of one company, for example, and something goes wrong, you could potentially lose some or even all of your investment.

But if you are invested in a range of companies, across different countries and sectors, the chances of them all having a problem at the same time is much lower.

Within share investments, investors might choose to have some exposure to growth shares that could be volatile but might experience more capital growth, and some in blue chip shares paying solid dividends but potentially not experiencing as much share price growth.

Beyond the individual investments themselves, investors often diversify across asset classes, too. These tend to respond in different ways at various points of the economic cycle.

Depending on your risk profile, you might have some of your investments in shares, some in bonds, some in property and some in cash. We can help you work out your risk profile and what sort of investment settings might suit you.

Diversification allows investors to strike the appropriate balance between risk and growth for their own circumstances.

Geographical diversification

You may also choose to diversify your portfolio by geography. This can be particularly helpful for investors in a small economy such as New Zealand. If you work for a local company and also own real estate, you may be more financially tied to the fortunes of the local economy than you initially realise.

Geographical diversification can help combat that. Spreading your investments into other countries’ assets can reduce your investment portfolio’s vulnerability to a domestic shock.

Managed funds

Some research has shown that it might require investments in 20 or 30 stocks to achieve an adequately diversified portfolio. But if you are just starting out in investing, or do not have a large sum of money, it can be hard to achieve that scale as an individual.

For many investors, managed funds are part of the solution. Some diversify further by choosing a range of funds with differed focuses.  

Regular review

It is often helpful to regularly review your portfolio to ensure your diversification settings remain appropriate. As investments’ values change, it can alter your exposures. We can help you check-in to stay on track.

Like some help?

We are here to help with any investment or diversification-related questions you may have. If you’d like to discuss your goals and current investment plans, get in touch with a SHARE adviser near you.

Disclaimer: Please note that the content provided in this article is intended as an overview and as general information only. While care is taken to ensure accuracy and reliability, the information provided is subject to continuous change and may not reflect current developments or address your situation. Before making any decisions based on the information provided in this article, please use your discretion and seek independent guidance.