Why is diversification important?

Diversification means spreading out where you invest your money – in different companies, industries and assets – to maximise returns and reduce risks associated with events like market crashes or recessions. 

Think about how different businesses performed at the beginning of the COVID pandemic. When borders closed, travel-related industries took a significant hit. If you were only invested in airline shares, your portfolio might have suffered as well. Other industries fared better, like tech companies that supported remote work. 

Diversification also means accessing different types of assets. Bonds generally provide a safe and stable return, but it is lower than the average return of riskier assets like shares or property. Including government or corporate bonds in a portfolio can give it a bit of certainty if markets become volatile.     

You can also consider geographical diversification, like selecting options from different countries to further spread out the risk. Volatility in the US may not affect shares in Europe – and inflation in Asia may not affect bond prices in Australia. It’s all about spreading out the risks and looking for opportunities to maximise growth opportunities. This will help you limit what’s known as systemic risk, which can include inflation rates, political instability or war. Systemic risk isn't limited to any one company or industry. 

Are there any downsides to diversification?

While the importance of diversification is one of the most common phrases in the investing world, there may be downsides. 

If you’re investing directly in shares or bonds, managing your various investments can become challenging as you acquire more assets. There have also been studies about diversification providing diminishing returns past a certain point. 

It can also be expensive both from transaction and brokerage fees for buying and selling but also with different fees charged for holding and managing investments. Do-it-yourself investment diversity can end up being stressful and expensive by taking up your time and fees that can eat away at your investment balance. 

While diversification can help you limit risk, it will not eliminate it completely. If a company that you’re invested in goes under – for whatever reason – you will still experience a loss. The benefit of having a diverse portfolio is that the loss will be limited. 

How do I diversify my investments?

There are two ways you can diversify your investments. Either you can do it by directly buying different types of shares or properties to create a portfolio that carries the level of risk you’re willing to take on. Here’s an example of what a diversified portfolio may look like. 

Are there any downsides to diversification?

While the importance of diversification is one of the most common phrases in the investing world, there may be downsides. 

If you’re investing directly in shares or bonds, managing your various investments can become challenging as you acquire more assets. There have also been studies about diversification providing diminishing returns past a certain point. 

It can also be expensive both from transaction and brokerage fees for buying and selling but also with different fees charged for holding and managing investments. Do-it-yourself investment diversity can end up being stressful and expensive by taking up your time and fees that can eat away at your investment balance. 

While diversification can help you limit risk, it will not eliminate it completely. If a company that you’re invested in goes under – for whatever reason – you will still experience a loss. The benefit of having a diverse portfolio is that the loss will be limited.