3.4 Diversification

What this topic covers:

  1. What is diversification?
  2. How to diversify
  3. Defensive and growth investments
  4. Easy ways to diversify
  5. Diversifying across your share portfolio

What is diversification?

Just as businesses like to develop new products and services so that they have a range to market – and don’t rely on one – investors may also need to consider the benefit of moving beyond a single investment. So, in financial terms, diversification involves investing in a variety of assets (see below) in order to reduce the exposure (and risk) to one particular asset.

Diversification is often referred to as a defensive strategy because it can be used to reduce the risk of the likelihood that a single event or situation will pose a large threat to your portfolio. In the long term, being diversified appropriately can help your portfolio weather the fluctuations of the share market without suffering a significant loss.

How do I diversify?

Diversification looks at your portfolio as a whole. Here are some of the different ways you can diversify by spreading your investments across:

your age Asset classes

For example, property, shares, cash

your career Market sectors

Buying shares in a variety of companies across diverse market sectors like energy, healthcare, materials, industrials etc

your lifestyle Markets

Investing in overseas markets and economies, for example through ETFs,

Risk Investment funds

Investing some money into managed funds,

Defensive and growth investments

Another way you can diversify your portfolio is to invest in a mix of defensive and growth assets. Defensive investments have less risk but do not usually grow in capital value, with returns generally lower than growth investments over the medium to long term. Examples include:

  • Cash
  • Fixed interest (i.e. term deposits)

Growth investments have the potential to produce higher returns over the medium to long term, even if returns fluctuate over the short term. Examples include:

  • Property
  • Shares

Diversifying through Exchange Traded Funds (ETFs)

Investing in ETFs can be a good way to diversify. This is because even a single investment in an ETF can give you exposure to a range of companies, assets and sectors. (Whereas if you buy shares in a company, all your money is tied up in that one company/sector.) If you’re interested in ETFs, the CommSec Pocket app is a great way to get started. We’ve picked seven investment themes for you to choose from, so you can invest in something that matters to you – like tech, sustainability, healthcare and more.

Diversifying within your share portfolio

With more than 2,000 companies listed on the ASX, there’s plenty of opportunity to diversify within your share portfolio. Finding the right mix of companies can help reduce the risk of losses in your overall portfolio. Here are some ways you can diversify when you’re looking at which companies to invest in:

  • By size – i.e. small caps, mid caps, or large caps
  • By market sector – i.e. energy, financials, telecoms, healthcare and so on
  • By factors that influence sector performance – cyclical, or defensive

When you’re looking at your portfolio, or researching a new stock, consider the size of the company, the market sector it operates in, and whether it’s sensitive to the economic cycle. If all your investments have the same characteristics, your portfolio might not be diversified enough to reduce your overall level of risk.

That concludes topic 3. You’re now well on your way in your investment learning journey. We hope you’ve got a good grasp on the “why” of investing and the fundamentals that underpin it. Next, we’ll show you the “how”, with a look at researching and trading using CommSec tools. Before you get started, why not complete the quick quiz?'

Next topic: 3.5 Quick quiz


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