3 simple ways to diversify your portfolio

The Australian share market is like no other in the world. Not only is our dividend imputation system unique but so too is our sector makeup.

It’s not surprising financial and resources companies dominate, representing 60 per cent of the share market by market capitalisation. Reserve Bank of Australia (RBA) research indicates this makeup has not shifted much over the last century.

However, a look at the average Australian share portfolio shows this concentration in a small number of sectors may be causing an unintended level of risk, as many portfolios closely replicate this sector concentration.

I would urge any investors reading this to compare your portfolio construction to the Australian share market and the average Australian share portfolio to see if concentration is an issue that needs addressing in your individual circumstance. The insights can help you not only increase diversification but also boost total returns.

How the average portfolio stacks up

Analysis of the average Australian share portfolio shows many investors are closely replicating the broader market. Almost 35% of the average portfolio is allocated to financials and over 20% is allocated to resources and materials. Aside from health care, exposures to other sectors sit well below 10%.

For the average Australian, this means the performance of their share portfolio relies predominately on just two sectors. Despite much being heralded about diversification in recent years, comparison with 2017 data shows allocations to the financial and resources sectors are steady.

How diversification impacts returns

We all know the theory, don’t put all your eggs in one basket. The premise behind this theory is that diversification reduces the risks associated with the performance of each asset class, sector or individual stock, and protects your portfolio from seismic volatility shocks. When returns for one asset class are low, returns for another may be high, decreasing volatility across the overall portfolio.

Portfolio modelling shows you can reduce the risk associated with your portfolio by adding in lower risk asset classes, without significantly impacting your total return. It’s important to note that the risk of investing can never be fully eliminated, but it can be greatly reduced through diversification efforts.

Simple ways to diversify

Diversification via individual stock selection can be time consuming and difficult without the right tools.

Fortunately, there are some investment options that provide simpler and more efficient ways for individual investors to access to a wide range of assets in a short period of time.

One easy way to diversify is to invest in global markets or specific asset classes via an Exchange Traded Fund (ETF), which can track an entire market or sector at low cost. There are several different ETFs that can provide you with access to shares in markets around the globe, or you can choose one that focuses on a single country, or sector, or theme. Whether you want to invest in a range of tech stocks like Apple, or the entire US market, there is an ETF to suit you.

Given their ease of use, ETFs are becoming increasingly popular among Australian investors. The number of people using ETFs grew by 23% to 385,000 last year according to the Investment Trends ETF Report 2018. Investors also like ETFs because they tend to have low annual fees, start with a small minimum investment, and can be bought and sold like shares.

Another simple method is to invest in an unlisted managed fund via the mFund platform. According to Investment Trends, almost a third of self-managed superannuation fund (SMSF) trustees are considering investing in international shares via managed funds, as they look to diversify their portfolios.

When you invest in managed funds, you can access instant diversification into a range of usually restricted assets, and the specialised strategies and expertise of investment managers. mFund is an innovative product from the ASX that allows investors to invest in unlisted managed funds through their stockbroker, effectively making lengthy forms a thing of the past and letting you buy, hold and sell units in a broad range of funds through a similar process to buying shares.

For many people, it may also be worth considering diversifying into Exchange Traded Bonds (XTBs), another innovative ASX product that provides access to a wide range of corporate bonds from ASX 100 companies, previously only available to institutional investors. Traded on the ASX in the same way as shares, XTBs offer a regular and predictable income stream, capital stability and greater security of capital repayment than shares or hybrids.