We have all heard the investment saying of “don’t put all of your eggs in one basket”, but what does it mean in reality? Investors need to truly understand diversification and better diversify their portfolios.
The benefits of a well-diversified portfolio are numerous but the key ones that investors should focus on are the benefits of mitigating volatility and short-term downside investment risks, preserving capital and the long-run benefits of higher overall returns. By spreading a portfolios investments across different asset classes, strategies and markets offering different risks and returns, investors can better position themselves for a secure retirement.
Surprising and a little concerning is that 82% of investors believe that diversification is important but in practice many do not achieve it.
Half of the respondents to the survey conducted by the SMSF Association cite barriers to achieving diversification. The top being that it is not a primary goal for investors, and they believe they have a lack of funds to implement it.
Furthermore, 36% of investors say they have made a significant (10%) asset allocation change to their SMSF over the last 12 months. This demonstrates that SMSFs may not be actively restructuring their portfolio on an annual basis to respond to changing market conditions.
Another clear problem regarding diversification is the amount of SMSFs with half or more of their SMSF invested in a single investment. investors say they primarily invest in shares to achieve diversification in their SMSF, while just a quarter say they invest in at least four asset classes to achieve this.
The bias and significant allocation to domestic equities conversely may highlight the fact that investors portfolios are not adequately diversified, especially across international markets and other asset classes. With potential changes to the franking credit flagged from the Labor Party we have seen a shift in asset allocation towards global equities and away from ASX high yield businesses. This represents an awareness from investors looking forward at potential reduced tax benefits associated with franking credits.
I would expect the trend for greater global allocation of assets to continue as investors rotate from a domestic bias to seek greater growth prospects and diversification. It also adds an additional opportunity to get currency diversification which can complement a traditional asset mix.
So what can you do?
Some of the steps you can take to diversify your retirement savings and control your investments in a disciplined and planned way include:
Always remember to document your actions and decisions, as well as your reasons, and keep them as a record in order to demonstrate that you know your investment strategy. By having a clear strategy that incorporates diversification to refer back to, it lowers the risk of impulse and irrational investment decision making.
Post contributor: Pete Pennicott | Principal Adviser
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