You may be investing to increase wealth but diversification has a different, but complementary, purpose: to help minimise your risk as you persue that goal. So it’s important that your blend of investments reflects not just your goals but also how you feel about risk.
The way you spread your money across different investments within a portfolio is known as your “asset allocation”. It involves identifying the investments that are right for your goals and risk tolerance and allocating a certain percentage of your portfolio to each asset class. For example, an investor may decide that, based on their individual circumstances, a portfolio holding Australian shares (45%), international shares (15%), fixed interest securities (30%), and cash (10%) is right for them.
Finding the blend of investments that best suits you is a key decision for you as an investor. There are some general guidelines to consider, though it may be worth considering speaking to a financial adviser to help you decide on the right investment mix.
Take a look at your short term goals. If you are investing to, say, fund some travel in the next few years, think about investing in an asset that contains lower risk, like a high interest savings account or term deposit. The return your money earns may be lower than what growth assets like shares and property offer over the longer term but it won’t be subject in the same way to market fluctuations. This is important as with a shorter investment timeframe there is less opportunity to ride out any market fluctuations.
A retiree may also consider keeping a few years’ worth of income in cash-based assets. This can help to avoid a potential situation where you need to sell higher risk/higher return assets like shares to access income to live on during a market dip when values may be low.
Whether it's money you’re growing for a deposit on a home or maybe to help fund a career break further down the track, money that will not be needed for a few years can be invested in slightly higher risk (and potentially higher return) investments.
A portion of your investment allocated directly into fixed interest securities or bonds, or via a managed fund that invests in each of these assets, might fit the bill.
Growth assets like property and shares (both Australian and international) generally have the potential to deliver higher longer-term returns. However, their values can swing, sometimes markedly and sometime rapidly, over the short term.
If you are in or near retirement, it can be tempting to put all your money into cash or other lower risk investments, like term deposits. After all, your money will be safe and relatively accessible. But increasing life expectancies for both women and men mean growth assets like shares arguably have a role to play in these more conservative portfolios.
A man aged 65 today, for instance, can expect to live another 19 years (life expectancy 84 years).1 That figure rises to 22 years for a 65-year old woman (life expectancy 87 years)1. This means you could have lots of living ahead. You don’t want your money running out before you do, plus there is time to recover from market downturns. A portfolio with a portion invested in growth assets like shares and property could allow you to take advantage of their gains over the longer term.
The bottom line is that, whilst your asset allocation should reflect how you feel about risk, the question of when you need cash and how long that cash needs to last can also influence where you invest your money.
1Australian Institute of Health and Welfare, Life expectancy http://www.aihw.gov.au/deaths/life-expectancy