Diversification means spreading out where you invest your money – in different companies, industries and assets – to maximise returns and reduce risks associated with events like market crashes or recessions.
Think about how different businesses performed at the beginning of the COVID pandemic. When borders closed, travel-related industries took a significant hit. If you were only invested in airline shares, your portfolio might have suffered as well. Other industries fared better, like tech companies that supported remote work.
Diversification also means accessing different types of assets. Bonds generally provide a safe and stable return, but it is lower than the average return of riskier assets like shares or property. Including government or corporate bonds in a portfolio can give it a bit of certainty if markets become volatile.
You can also consider geographical diversification, like selecting options from different countries to further spread out the risk. Volatility in the US may not affect shares in Europe – and inflation in Asia may not affect bond prices in Australia. It’s all about spreading out the risks and looking for opportunities to maximise growth opportunities. This will help you limit what’s known as systemic risk, which can include inflation rates, political instability or war. Systemic risk isn't limited to any one company or industry.