5 golden rules of diversification

Most of us agree that it’s important to spread our investments across all asset classes, but when there is one clear winner – and that’s currently property – it’s tempting to ignore this advice. So I’ve come up with five rules of diversification to reduce your risk and still protect your returns.

1. YOU NEED TO KEEP SOME OF YOUR ASSETS IN CASH OR IN A BUFFER

If you already own properties, then your buffer is probably in the form of an offset account, a line of credit or both, which is even better. Offset accounts should be used as a buffer for all non-tax-deductible income and expenses, and lines of credit should be used for investment income and expenses. Keeping cash in a savings account automatically attracts income tax, so you need to be smart about how you structure your buffers.

Whichever way you choose to build these buffers, they are a must for risk management but can double up as a form of diversification in the future. It is not a case of “Should I?” but “How and where?”

2. SHARES ARE VOLATILE BUT IT’S NOT ALL ABOUT CAPITAL GROWTH

If you look at the value of the Australian share market since its highs in 2007, the S&P All Ordinaries Index remains 16% lower in value. Of course, not all stocks track the index. Bank stocks, for example, strongly outperformed the overall market over this time.

There’s no denying the volatility of the share market. In boom times gone by, share investors who did not diversify into other assets suffered devastating losses as values crashed overnight. You only have to remember the ‘tech wreck’ of the early 2000s. Despite this volatility, investors should include shares as part of an overall diversified approach to investment. The reason? As well as reducing your risk in the unlikely event that your other investments all lose value in a short period of time, many shares pay good dividends and offer franking credits that put more money back into share investors’ pockets. This is a useful income stream that increases your overall returns from share market investments.

3. DIVERSIFY WITHIN PROPERTY

Property ticks all the boxes. You can leverage to increase your returns; you can claim tax losses from property investing against other taxable income; long-term growth is strong; and with the increasing population there will always be demand. As I said, it’s difficult to convince some investors of the need to diversify out of property.

4. DON’T FORGET SUPERANNUATION

You may be more diversified than you think. Perhaps you hold mostly property investments in your own name, but remember the 9.5% you are paying out of your salary each month? Well, chances are your superannuation fund is substantially invested in the share markets, locally and globally, and it will also invest in cash. It may be a very shrewd move to talk to a competent financial planner and discuss the investment mix in your super to provide additional diversification and also take advantage of investing in the concessionally taxed environment that superannuation offers.

5. REVIEW REGULARLY

It is impossible to time the market precisely, but reviewing your assets regularly with a competent professional will reduce your risk. Have your properties valued regularly. Maybe you are in a position to invest in another property? Maybe you need to rebalance as you grow older. Perhaps you could also be salarysacrificing into superannuation?

No matter how much you love and feel comfortable with property, you must keep a view of the big picture and an eye open for other investment opportunities. Diversification offers you vital protection. My personal strategy is simple: my superannuation account is my exposure to shares, and I own my properties in my own name. I also have offset accounts and lines of credit, so I feel comfortable with my diversification structure.