10
DIVERSIFICATION: HOW TO ENJOY YOUR FREE LUNCH Diversification has been called “the only free lunch in investing”. So how does it work and how does it benefit you? By MARTIN HESSE “SPREAD your bets.” “Don’t put all your eggs in one basket.” The benefits of diversification have long been known to mankind, as these well-used phrases confirm. Yet how often do we hear of people losing their entire life’s savings through a single failed investment? While on the face of it the concept is simple enough, to structure a well-diversified portfolio requires some effort and thought. There are different ways of diversifying your investments, depending on your investment goals and time horizon. Higher-risk investments, such as shares and property, are necessary in a long-term portfolio for
achieving above-inflation growth. However, the risks associated with these asset classes need to be carefully managed, and diversification is key to managing risk. Lack of diversification leads to concentration risk, the investment industry term for having all your eggs in one basket. In an article for Forbes magazine, “How diversification works, and why you need it”, Rob Berger and Benjamin Curry explain that diversification is not designed to maximise returns in the short term. “At any given time, investors who concentrate capital in a
limited number of investments may outperform a diversified investor. “Over time, however, a diversified portfolio generally outperforms the more focused one,” they say. HOW TO DIVERSIFY YOUR INVESTMENTS The secret to diversification is noncorrelation. If two assets are correlated, they move up and down in tandem; if they are noncorrelated, the one will move up while the other moves down – in other words, the same market conditions will affect the assets in different ways. You can find a degree of
