Diversification simply means not putting all your eggs in one basket. This means ensuring that exposure to one asset class, or one security in a particular asset class, does not distort the balance of your overall portfolio. Modern investment planning (portfolio) theory has clearly shown that investing in a range of securities across a range of investment classes lessens the risk of investing. The principle of protecting the downside maximises gains over time.
For example for each $100 invested which loses $50, you must earn 100% on the $50 remaining to get back to where you started. If $100 invested lost $10 you must earn 11% to get back to $100. This is very much like the story of the tortoise and the hare.
This principle is based on the fact that investment markets do not all move in the same direction at the same time. They move in cycles and will behave in different ways under different economic circumstances and climates.
- Fixed Interest
Each class has a domestic and an international element. By spreading investments across the classes both domestically and internationally provides diversification across the different asset class cycles.
Historical evidence based on United States' statistics between 1926 and 2006, shows a clear difference in returns achieved by the various asset classes. After inflation these compound annual returns have been:
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