Investors are often hearing from professional advisers about the importance of diversifying investments across a range of asset classes. But what is the reason for this?

Spreading your investments across a range of asset classes is akin to the well-known adage of “don’t put all your eggs in one basket”. It is the primary tool that can be used to reduce the risk associated with investment.

Investment risk comes in many forms – volatility risk, inflation risk, credit risk to name a few, but most importantly the risk of permanent loss of capital. Spreading your investment across a range of assets reduces the risk of a permanent loss of capital.

A diverse portfolio can also be used to enhance investment returns. Different types of assets perform differently in different market conditions. By holding a range of assets, investors can benefit in all markets. But that is not all.

A prudent investor can also use volatility in markets to their advantage. By spreading their investment in set proportions across a range of different asset classes (such as cash, fixed interest, Australian shares, international shares and property) they can re-balance their portfolio when markets move. This approach to investment is called using a “strategic asset allocation”.

For example, consider a portfolio with a spread of investments across the asset classes mentioned above. If the Australian share market was to fall by 30% (this is what happened in March 2020), then the investor could at that time move some money from fixed interest and cash into shares to rebalance the portfolio back to their original asset spread.

Then, when the share market inevitably recovers, they can again review their portfolio to sell down their now overweight position in shares and place the money back into fixed interest and cash.

The active process of rebalancing a portfolio sounds easy in theory. In practice investors also need to contend with their own emotions. It can be difficult to make changes to a portfolio, such as buying shares after the market has fallen 30%, however this is when real value can be added to investment performance.

Using a strategic asset allocation and rebalance approach to investment assists investors to make prudent decisions with their portfolio, reduces investment risk, and can improve long-term investment outcomes.

At Hewison Private Wealth we have been designing client portfolios using strategic asset allocations to meet specific client objectives for nearly 40 years. Our experience in a wide range of markets has informed our prudent approach to assisting clients to achieve their goals and dreams. If you are not already a client, and this is of interest, then please contact us.