Diversification

Understanding investment basics

It's important to understand a few investment basics before you start to invest. There are three major things to be aware of:

• the different types of investments and how they perform
• the relationship between risk and return
• and why diversification is essential for a sound investment strategy

This page covers diversification.

Keeping up with changes to tax legislation, superannuation regulations, market movements and tracking investment performance can be time-consuming and difficult. A Commonwealth Financial Planner can guide you through this maze of complex information and work with you to identify a strategy that meets your investment goals.

What is diversification?

Diversification is the process of investing your money across a range of different investments to reduce risk. The exact mix of investments you choose depends on:

• Your financial objectives
• The amount of time you have available to invest
• Your personal tolerance for risk

 

Why diversify?

Diversification is important because no single type of investment consistently performs better than another. They all have their ups and downs. Owning a diverse range of investments means you'll never equal the top return available in any given year, but you shouldn't equal the lowest one either. Instead, you should chart a smoother, more consistent course somewhere between the two extremes (depending on your chosen mix of investments).

It might not sound exciting, but diversification is a proved strategy that has been used successfully by generations of investors. All professional investment managers use diversification as a means of reducing investment risk.

The more ways you diversify, the more you can reduce your risk. For example, you can invest:

• Across different investment types or asset classes (cash, fixed interest, property, shares)
• In more than one investment within each type (e.g. invest in several different industries and companies when investing in shares)
• In more than one type of fund, and more than one fund manager, when investing in managed funds
• Into different investment environments, such as inside or outside of super.

 

Diversification in action: an example

Let's say you had all your money invested in just one investment and that investment didn't perform - you'd make a loss. However, if you spread your money across different types of investments you might still make a loss on some investments, but you'd probably also have some investments that perform well, thus reducing your risk of overall loss.

EXAMPLE
Single investment	Value on	Average annual return	Value on
	1 Jan 2000		1 Jan 2005
Shares in Widgets Inc. Australia	$50,000	- 3%	$42,937
TOTAL	$50,000	- 3%	$42,937
Diversified investment portfolio
	1 Jan 2000	Increase/Decrease	1 Jan 2005
Shares in Widgets Inc. Australia	$5,000	- 3% p.a.	$4,294
Shares in Widgets International	$15,000	+ 12% p.a.	$26,435
Shares in Computing America	$10,000	- 2% p.a.	$9,039
Fixed interest	$5,000	+ 6% p.a.	$6,691
Property shares	$10,000	+10% p.a.	$16,105
Cash	$5,000	+ 5% p.a.	$6,381
TOTAL	$50,000	+ 2.6% p.a. average	$68,946

This example is for illustrative purposes only and does not represent the past or future return of any product or strategy offered by Colonial First State.

Seek advice on the investments and strategies that will suit you

Whether you're an expert or novice investor, good advice is important. Commonwealth Financial Planners specialise in helping you make the right investment decisions. A Commonwealth Financial Planner will work with you to develop a diversified financial plan designed to achieve your personal financial goals.

To find out more about how a Commonwealth Financial Planner may be able to help you, or to make an obligation-free appointment with a Commonwealth Financial Planner call 1800 241 996 or email us.

Important information

• This is not advice, this provides general information only and does not take into account your individual financial circumstances or investment objectives. You should assess whether the information is appropriate for you and consider talking to a financial adviser before making an investment. Investment products are subject to investment risk including the loss of income and capital invested. Colonial First State Managed Investment Funds, FirstChoice Investments and FirstChoice Wholesale Investments are issued by Colonial First State Investments Limited ABN 98 002 348 352 AFSL 232468. Product Disclosure Statements (PDSs) describing the products are available by contacting Investor Services on 13 13 36. You should consider the relevant PDS before making a decision about the product. The responsible entity, Colonial First State Investments Limited receives fees.
• Commonwealth Financial Planners are representatives of Commonwealth Financial Planning Limited ABN 65 003 900 169 AFSL 231139. Commonwealth Financial Planning Limited is a wholly owned but non-guaranteed subsidiary of Commonwealth Bank of Australia ABN 48 123 123 124.