How to build a diversified portfolio

Many investors are aware of the importance of having a diversified portfolio, but may be confused as to whether their money is in fact diversified or not.

This guide will teach you what a diversified portfolio is and the benefits of having one. It also offers an easy five point checklist to assess whether your money is diversified or not. If it’s not, don’t worry, we also provide some advice on how to ensure it is diversified.

What is a diversified portfolio?

As the name suggests, a diversified portfolio is an investment portfolio with diversity. This means that the investor has a range of different assets in their portfolio, rather than only investing in the one asset.

For example, if you have all your money sitting in a savings account, you do not have a diversified portfolio. Similarly, a property investor who owns numerous investment properties but does not have any other investments doesn’t have a diversified investment portfolio, as they are only investing in the one asset class (property).

They may, however, have a diversified property portfolio, meaning they invest in a range of different property types such as houses, apartments and land.

The benefits of a diversified portfolio

The main benefit of having a diversified investment portfolio is that it minimises risk. Like the common phrase “don’t put all your eggs in one basket”, the same applies to investing. Because, in the unfortunate event that something were to happen to that basket, all your eggs - or money - would be gone.

If one investment class performs poorly over a certain period, having a diversified portfolio means you will only lose money on your investments in that asset, rather than across your whole portfolio. For example, if you only invested in shares in Australian companies, your entire investment portfolio would be affected each time the market fluctuates. However if only one quarter of your portfolio was in shares, only one quarter of your portfolio would be affected.

It is also of benefit to diversify your portfolio within particular asset classes. For example, if you’re investing in shares, investing in a range of different sectors and industries will further help minimise risk to your investment portfolio as a whole.

Five signs your money is diversified

1. You aren’t phased by short-term performance

If your money is properly diversified, you generally aren’t concerned about what the market does on any particular day. If small market fluctuations are keeping you up at night, this could be a sign that you have too much money invested in one particular asset class.

2. You’re in it for the long term

Investors with diversified portfolios are generally in it for the long term and are investing to create future wealth. This is compared to investors that may invest a large pool of money into one asset for a short amount of time. If you’re investing with the intention to sit tight for the next 20,30 or 40 years, you will likely have a diversified portfolio.

3. You ignore trends and market hype

Investors who don’t have a properly diversified portfolio are likely to get caught up chasing the next big investment opportunity. For example, they might keep an eye out for shares that are underpriced with the intention to buy and sell and make a quick buck. However, if your portfolio is diversified, it is more likely that you’re confident with your investments because you have a stable, well planned, long term strategy.

4. Your money is invested in a variety of the traditional asset classes

The more asset classes you’re invested in, the more diversified your portfolio is, meaning it is also lower risk. If you have money invested in two or more of these asset classes, you have a diversified portfolio.

• Cash. This includes term deposits, savings accounts and cheque accounts.
• Australian shares. Also referred to as equities, share trading is the partial ownership of a publicly listed Australian company, such as one of the major banks. These are traded on the Australian Stock Exchange (ASX), and you earn a portion of the company’s profits in the form of dividends.
• Global shares. This is the partial ownership of a publicly listed international company.
• Property. This includes direct ownership of residential or commercial property. It can also include partial ownership of property through a managed fund such as Brickx.
• Commodities. This includes natural resources such as coal, copper and iron-ore and precious metals such as gold and silver.
• Bonds. Bonds are a form of tradable loan that can be bought and sold in a similar way as shares. Bonds are loans made to a government entity, with investors earning money out of the interest payments on the loan.

5. You invest in Exchange Traded Funds (ETFs)

An ETF is a type of managed fund that is traded on the ASX like shares. The fund owns a range of assets including local and global shares, bonds, foreign currencies and commodities. The investor does not own these underlying assets, but instead owns a portion of the entire ETF. Therefore, even if you only invest in ETFs, you automatically have a diversified portfolio.

If your money isn’t already diversified, here’s how to make sure it is.

If you have completed the above checklist and realised you only have money in Australian shares, a simple way to diversify your portfolio is to invest in some international companies. You are already comfortable with the process of trading shares, so this a good way to diversify your portfolio without adding too much additional risk. In the event that the Australian economy crashed and the share price for all ASX listed companies dropped, you would be pleased to know your international shares would be largely unaffected.

Another simple way to ensure your money is diversified is to invest in ETFs. Rather than learning the intricate details of each individual asset class and trying to asses which to invest in, and ETF will do the hard work for you. This is a great option for new investors who are just dipping their toes in the water.