Keeping your Baskets in Order

Diversification is a key principle to live life by. Most people tend to think of it in a financial context, but it can apply to various aspects of life. Having a good work-life balance and getting fulfilment from multiple facets of life is a great example.

The benefits of good financial diversification are not to be scoffed at. Most importantly it manages risk and reduces the impact a bad event in any one asset has on your overall financial wellbeing. There can be a number of things which impede good diversification though. It can be getting emotionally attached to a single investment or preferring certain investments for reasons that aren’t 100% objective.

Emotional investing

We often come across stories of people who have ended up with a large holding in a single investment due to a number of different reasons. One common example is getting attached to a stock that has done very well. Naturally people can often form an emotional attachment to these companies and find it difficult to part ways with the investment. It can leave them over exposed to that company and not fully appreciating the risk to their wealth that position has.

This emotional attachment is also linked closely to a bias where people put more value on an asset they own, simply because they own it. To illustrate the two biases together, imagine a company whose share price has risen 100% over the past year. Someone who bought into the company before the 100% rise is much more likely to continue to own shares in the company than someone who has watched the stock rise, even though the value of the company to both investors is exactly the same.

To help mitigate emotional investing and make sure you’re adequately diversified, a great general rule to follow is no one company should make up more than 5% of your net wealth.

Protect against Market Volatility

One of the primary reasons for diversifying your investments is to protect against market volatility. Markets can be unpredictable, and different asset classes often react differently to the same economic events. By spreading your investments across a variety of assets, you can reduce the impact of market fluctuations on your overall portfolio.

Market volatility refers to the frequency and magnitude of price movements in financial markets. High volatility can lead to significant losses if your investments are concentrated in a single asset or asset class. Diversifying your portfolio can help smooth out these fluctuations, providing more stable returns over time.

Our Approach

Here at Compound Wealth, diversification is at the forefront of our investment philosophy. By investing in a mix of assets and diversifying investments within asset classes we can reduce the overall risk of your portfolio and provide smoother returns over the long-term.

If you are interested in restructuring your investment portfolio, or if you’d like to learn more about your KiwiSaver’s asset allocation, please reach out for a quick chat, or complete one of our quizzes below and we will be in touch.

Compound Wealth is a KiwiSaver, Retirement and Private Wealth Financial Advice Firm based in Mount Maunganui, Bay of Plenty.