What is diversification and how does it work?

The rundown

  • Diversification is when you spread your investments across different things like stocks, bonds, or real estate to protect yourself from risks.
  • It is considered a defensive strategy, as diversifying your portfolio can help your portfolio weather market fluctuations in the long run.
  • Diversify your investments by spreading your investments across asset classes (such as cash, property, shares, bonds), market sectors (such as healthcare, energy, materials and more), markets and geographies, and investment funds such as Superannuation and Unit Trusts.
  • You can also diversify your portfolio by investing in a range of Defensive (low risk, low return) and Growth (high volatility, high return) investments.

What is diversification?

Diversification is when you have a mixed bag of investments to protect yourself from risks. Instead of putting all your money in one place, you spread it out across different things – such as stocks, bonds or real estate.

Diversification is often referred to as a defensive strategy because it can be used to reduce the likelihood that a single event or situation will pose a large threat to your portfolio, for example, a global conflict or political event. In the long term, diversifying your investments can help you and your portfolio weather the fluctuations of the share market without suffering a significant loss.

How do I diversify?

Diversification looks at your portfolio as a whole. Here are some of the different ways you can diversify by spreading your investments across:

Asset classes
Invest across different asset classes, such as property, shares, cash and bonds. Exchange Traded Funds (ETFs) are a great way to diversify your portfolio, because a single investment in an ETF can give you exposure to a range of companies, assets and sectors.

Market sectors
Invest in shares and ETFs across a variety of industries, such as energy, healthcare, materials, industrials and more. 

Markets

Invest across different overseas markets and economies.

Investment funds

Some investors opt to invest some money into managed funds, which are pooled together and managed by Fund Managers, for example, Superannuation Funds, Unit Trusts, Annuities and Allocated Pensions.

Investors can also diversify their portfolio by investing in a mix of defensive and growth assets.

Defensive assets

  • Defensive assets incur less risk but usually don’t grow in capital value.
  • Returns are generally lower than growth investments over the medium to long term.
  • Examples include cash or fixed interest investments like term deposits.

Growth assets

  • Growth investments have the potential to produce higher returns over the medium to long term but can come with higher risks.
  • Returns may fluctuate over the short term.
  • Examples include property or share investments.

How do I diversify within my share portfolio?

With more than 2,000 companies listed on the ASX, and 13 global sharemarkets at your fingertips, there’s plenty of opportunity to diversify within your share portfolio. Finding the right mix of companies can help reduce the risk of losses in your overall portfolio. 

Here are some ways you can diversify when you’re looking at which companies to invest in:

  • By size: i.e. small caps, mid caps, or large caps
  • By market sector: i.e. energy, financials, telecoms, healthcare and so on
  • By factors that influence sector performance: cyclical, or defensive

When you’re looking at your portfolio, or researching a new stock, consider the size of the company, the market sector it operates in, and whether it’s sensitive to the economic cycle. If all your investments have the same characteristics, your portfolio might not be diversified enough to reduce your overall level of risk.

 

Glossary:

  • Market caps: Also known as market capitalisation, it is the measure of a company’s total market value.
  • Small caps: These are the companies that sit outside of the largest 100 on the ASX for market cap. Companies in this index typically have a market cap of a few hundred million up to $2 billion.
  • Mid caps: The next 50 biggest companies on the ASX in terms of market cap. Their market cap generally ranges from $2 billion to $10 billion.
  • Large caps: The biggest companies on the ASX in terms of market cap. Their market cap generally ranges between tens of billions to over $100 billion.
  • Economic cycle: The fluctuation of the economy between periods of growth (expansion) and contraction (recession). Factors such as gross domestic product (GDP), interest rates, total employment and consumer spending can help determine the current state of the economic cycle.
Next >
< Go back

CommSec Learn is intended to provide general information of an educational nature only. Any securities or prices used in the examples given are for illustrative purposes only and should not be considered as a recommendation to buy, sell or hold. Past performance is not indicative of future performance. Investing carries risk.

© Commonwealth Securities Limited ABN 60 067 254 399 AFSL 238814 (CommSec) is a wholly owned but non-guaranteed subsidiary of the Commonwealth Bank of Australia ABN 48 123 123 124 AFSL 234945. CommSec is a Market Participant of ASX Limited and Cboe Australia Pty Limited, a Clearing Participant of ASX Clear Pty Limited and a Settlement Participant of ASX Settlement Pty Limited.

The information on this page has been prepared without taking into account your objectives, financial situation or needs. For this reason, any individual should, before acting on this information, consider the appropriateness of the information, having regards to their objectives, financial situation or needs, and, if necessary, seek appropriate professional advice.

CommSec does not give any representation or warranty as to the accuracy, reliability or completeness of any content on this page, including any third party sourced data, nor does it accept liability for any errors or omissions.
Top