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Chapter 1: What is diversification and why is it important for investments?
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Chapter 2: How does mixing different asset classes reduce investment risk?
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Welcome to the Australian Finance Podcast, a podcast for people who want to learn more about their personal finances and get the most from their money. This series is hosted by Kate Campbell from HowToMoney and Owen Raskovich from Rask Finance.
The Australian Finance Podcast is provided for educational purposes only. The information is general in nature and does not take into account your needs, goals or objectives. What that means is the information does not apply to you specifically. So consider getting the advice of a licensed and trusted professional before acting on the information.
Kate, we're talking about diversification and it's titled The Building Blocks of Diversification. What an episode.
Yes, very excited, Owen.
Welcome. So what's this episode about?
So we wanted to talk a bit more about diversification because we probably mention it in every episode and maybe we don't explain what we mean by it too much. So we're talking about mixing different asset classes, different fund managers, everything together to hopefully reduce your risk in your investments by not having all your eggs in one basket.
Well, that's it. Thanks for tuning in, folks. That's the end of the episode. Not putting all your eggs in one basket.
That's what everyone tells you, right? We don't want to put all our investments in Broome at the moment.
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Chapter 3: What are the different types of diversification to consider?
Is there an ETF called Broome?
No, no, I'm just thinking like rooms, like in the household items, but okay, cool. So why don't we actually, why don't you actually give us the finance definition of what diversification is?
So we're spreading out our investments across multiple different places. So not just asset classes, fund managers, different countries, different currencies to help reduce the risk of our portfolio.
Okay, so let me get this straight. You're telling me that I can't put all of my money in gold?
No. Some would argue gold is part of a diversified portfolio.
But not all of it?
No.
Okay.
So by not putting all our money in gold, we aren't fully exposed to that one asset class. So if suddenly gold loses value, hopefully not our entire portfolio goes down with the ship. Okay. So if we maybe have some money in silver.
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Chapter 4: Why should you avoid putting all your money in one asset class?
Just as likely in Victoria? example but yes bushfire if you have all of your houses in the same suburb in the same bushfire prone area and there's a bushfire what that is is we call that like that's just like ultimate risk you're putting you're putting too much risk in one specific area and that's why academics call it specific risk yeah so it's like a risk that is specific to one thing but if it
So diversification won't stop that suburb being hit by fire. But what it will do is if you've only got one house in that suburb, the other nine won't be affected if you have 10. So that's what diversification does. It lessens the risk. It also means that if you still own 10 properties, you can still make a decent return. In other words...
What we're trying to do here, and this is a wonderful quote, Kate, and it comes from this website called restfinance.com. Yes. And it says, diversification narrows the range of return outcomes, but it doesn't necessarily lower the expected return. So...
Chapter 5: How does correlation between assets affect diversification?
You get, I guess, there's that saying that you can't do better than your best investment. You can't do worse than your worst investment. So it's like that's the opportunity. But with diversification, you don't necessarily have to give up all the best returns. You just lower some of the downside returns. So some of those risks on the downside, if that makes sense. Okay.
So let's talk about the different types of diversification. You've mentioned some of them already. You mentioned one about fund managers. Can you explain what you mean?
Yes. So I think if you're investing in managed funds or exchange traded funds, one thing to be careful is you don't have every single exchange traded fund from the same provider like Vanguard or BetaShares. You have a mixture. And with fund managers as well, some of the big ones in Australia have 10 or 20 or 30 different funds. So don't put all your money in the same.
So you might have it in different funds. You might have a global fund and an Asian fund and an Indian fund. But it could be still run by the same overarching company. So you're still not diversified fully there. And the same thing if you're letting one person manage your entire portfolio, then you've got the risk that they can get it all wrong.
Or they get hit by a bus.
Yeah. And that's sort of a key man risk there. So you're sort of spreading the load between different companies, different managers. And sometimes you think a company is really diversified and they might go into administration. So that has happened recently in Australia where they were invested in completely different products. So it looked very diversified, but the fund manager went kaput.
Just name them. Blue Sky. Yep. They just, yeah. You can Google Blue Sky.
Just trying to be a bit polite here, Owen.
No, I'll name them. All right. So it just happened to be Blue Sky. And they've pretty much, you look at this share price chart, Blue Sky has gone up, up, up, up, up, and then bang.
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Chapter 6: What are examples of bad diversification strategies?
Commodities? Commodities. Metals.
Yeah, that's the same thing. Okay. What might be another asset class?
It might be Australian equities. So Australian shares. We're talking CBA, Telstra, all those Australian shares. Another one? Australian property.
Property. Another one?
And then often Australian infrastructure. Sometimes that's separate, sometimes the same.
Okay, like big projects.
Yeah, warehouses, buildings, student accommodation. International, you can get international. Specifically, if you're looking at specific markets, you can target like India, emerging markets, Australia. What am I saying?
US.
US. Or you could go all world. And then you can get property over there too. So you could look at investing in property and infrastructure overseas. So all separate, so not completely correlated with each other. So US might be doing really well, Australia might not be.
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Chapter 7: How can a diversified portfolio help during market downturns?
We've talked about REITs. We've talked about... Listed investment trusts. Yep, listed investment companies.
And what about in terms of cash, also different countries' currencies.
Yeah, you can use US dollars. You can use ETFs to invest in US dollars, to invest in euros, whatever. You don't have to go down to your travel ex and pay like 4% commission just to get some Benjamin Franklin's. So what about let's just go all in and let's say people at home know what we're talking about. What's an example of bad diversification?
Okay.
Or no diversification.
You've bought one apartment and you have a $500 micro investing portfolio. Okay.
okay so you've got your only investments you have two you got a 300 400 500 000 apartment um and you've got 500 bucks in yeah micro investing account okay so that would be really bad because like 99 of your wealth is in property and one single property as well one single property okay what's another bad type of or what's in diversification gone wrong what's another example
Maybe too far the other way, you've got like 80% of your portfolio in cash and you're in your 20s and maybe the other 10% is in bonds and 10% is in shares.
Okay, so you got like 50 grand and you put like 40 grand of that in cash and the other 10 is like invested. So you're missing out on all the opportunities that are in front of you. Okay. Cool. I might throw a third one in and say, and this is one that I see a lot in Australia.
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Chapter 8: What are some practical tips for building a diversified portfolio?
And then the company went bust. So they lost their pension, lost their income, lost their assets. Really bad. But people don't think about that diversification in the personal finance sense. They only tend to think about it in a portfolio. But it applies to all walks of life.
Are you working in the healthcare industry and you're just only investing in healthcare companies? Maybe you understand it, you have a point of difference there in investing there, but also you're tying a lot of risk to your investments in the same industry as you work in.
Yeah. And so this is, as we'll get to in just a moment, it's not all one or the other, right? It's not all like you must have a certain amount of investments or you must not have that many. And we're saying like, it's a fine line between using what you know and having an expertise in a particular industry and taking advantage of that.
And then also having, I guess, a humility to be like, okay, I could be wrong about property. I could be wrong about the share market. I could be wrong about whatever it is. And just placing some emphasis on some other investments.
Yeah, and you might be completely right about a sector, but it goes through a rough patch. So by having a diversified portfolio, even if one of your bets is taking a long time to pay off, you've got a bit of stability through another part.
Yep, good one. Okay, so do you have any examples of good diversification or what someone might do?
So I guess one of the things I heard a lot, especially for older people is invest in your age in bonds. Okay. So if I'm like 80, 80% of, if I'm 80 years old, 80% of my portfolio should be in bonds. I guess for a young person, that's pretty irrelevant. I mean, right now I don't want 21% of my portfolio in bonds.
Okay. You're showing your age.
Yeah. Yeah. I think personally bonds are pretty boring, but I guess investing is not supposed to be that exciting.
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