Don’t Put All Your Eggs in One Basket

Old fashioned wisdom often has longevity because it is sensible. Diversification is simply about not putting all your investments in the one country, sector, investment type or security. With respect to investment management, diversification is a highly rigorous and disciplined process. Rigorous and effective diversification is not designed to be as exhilarating as a night at the casino (or a punt on a mining stock) but successful investors don't invest for the fun and excitement of investing: they invest to build sufficient wealth and passive income to afford the things they find fun and exciting. It's not the process of investing that needs to be exhilarating. It's the results – a better lifestyle and more freedom.

Many Investors Do Not Adequately Diversify

Most investors ignore the doctrine of Modern Portfolio Theory and instinctively overweight exposure to their home country. Many Australian investors work, live, bank, and invest only in Australian assets. Many invest only in a local region (eg: Gippsland or North East NSW). Not only does this practice dramatically increase risk, but under-diversified investors deny themselves rewards available in other asset classes and locations.

Modern Portfolio Theory on Diversification

Fifty years ago while reading about investing in the library of the University of Chicago, Harry Markowitz was suddenly struck by the notion that that "we should be interested in risk as well as return". Today it's hard for us to grasp quite how revolutionarily novel this revelation was, but back in 1952 risk hadn't yet been adequately defined, let alone incorporated as a crucial element of the investment process.

Risk Defined

Risk describes the chances of a forecasted result not happening. We instinctively prefer known outcomes to uncertain ones. By nature we humans are risk-averse. But because tomorrow's events have yet to unfold we have no choice but to continuously make decisions under uncertainty, in the face of risk.

Diversify into Uncorrelated Investment Cycles

Diversification into uncorrelated investment cycles is the primary defense against investment risk. And this superior, proven strategy allows investors to simultaneously capture the returns of a host of asset classes.

• Uncorrelated asset cycles are those that do not move up and down in tandem. For example, when bonds rise, stocks tend to fall; when Value-style investments rise, Growth-style investments tend to fall. Diversification into investments running on different cycles offsets the uncorrelated ups and downs to smooth overall portfolio return.
• Even better, the risk of a properly diversified portfolio is always lower than the average riskiness of the portfolio holdings. The implications of Modern Portfolio Theory are staggering: investors can substantially reduce portfolio risk without sacrificing return. AusAssured capitalises on this phenomenon for your benefit.

Chasing What’s Familiar or Hot

It’s dangerous to focus on potential return without regard for risk, but excited investors often pay insufficient attention to proper asset allocation, abandon the guiding handrail of diversification, and focus on whatever’s hottest. But a basket of similar investments simultaneously delivering peak performance is not a portfolio – it’s a gamble.
Because investments move in cycles, by definition the correlated (their value moves up and down together) investments in this basket will inevitably nosedive in tandem. Avoid this mistake. The point of portfolio construction is not to haphazardly collect a hodgepodge of investments selected on hunches, tips from friends - or because everybody else you know is buying them wildly in the hope of being blessed with spectacular returns over the next 12 months.

Diversification Through Managed Funds

A rational investor should be obsessed with producing satisfactory returns using effective risk techniques. True diversification elegantly manages the trade-off between risk and return, and properly selected managed funds provide cost-efficient access to significant diversification across the world's asset classes and asset categories.

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