Diversifying your investments. What it actually means, and how you should apply it to your situation.
The easiest way to explain diversification is the old concept of not putting all of your eggs in one basket.
If you just won the lottery and had a million dollars in the bank, and I told you to put every cent of it into, say BHP shares.
You’d probably think I was mad, and rightly so.
Why risk 100% of your wealth on a single investment?
Diversifying is smart, it’s spreading your wealth across a variety of investments, so as to ‘diversify’ the risk you are taking on.
A good balance of cash, shares and property is a great starting point.
The big mistake many young Australians make, and I’ve talked about this before, is purchasing a property with what little cash they have saved and essentially putting all their eggs in one basket.
A single property, with no cash buffer and no other investments in shares or managed funds, really is taking on more risk than necessary, although mostly we don’t see it that way.
My preference is to build a good cash position, then start investing in shares (maybe via a managed fund) and then when you have enough wealth built up diversify further into property.
This means, when the property market is up and the share market is down, you won’t be too concerned, and vice versa. It’s never a great feeling to be holding a single type of investment and for the bottom to fall out of that market.
Of course you can diversify even further within each asset class as you build more wealth, things like owning both commercial and residential real estate, or owning shares in different countries, or even different sectors of the market, like mining companies, and retails companies.
I think you get the idea.
The more you have, the more you will need to think about this, however the most important thing is just not to put 100% of your money into one thing, or you risk backing the wrong horse.