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How To Optimise Your Investment Risk Through Diversification

Diversification is a concept most investors are familiar with. But surprisingly, it can often be forgotten by even the savviest among us when exciting investment opportunities arise.


4 January 2021

Typical definitions of investment diversification focus on lowering risk by allocating money across a mix of asset classes, industries and geographies. The premise being that each would react differently to the samemarket events, thereby reducing your overall exposure to loss.

However, a potentially more progressive approach to diversification is to consider how it can be used not necessarily to reduce risk, but to optimise it within the context of your personal investment objectives.

Whether your investment portfolio comprises many different investment structures or is limited solely to your rental property interests and/or KiwiSaver, you have the opportunity (andability) to optimise your risk by carefully selecting where you invest your money.

To understand if your investments are diversified appropriately to meet your objectives and your risk exposure is optimised for your personal circumstances, you should ask yourself these three important questions.

• What’s my timeframe?
• What other investments do I have?
• What is my risk comfort zone?

1. What's My Timeframe?

Consider what time you have until you expect to use or withdraw your investment. For example, if you‘re new to KiwiSaver and plan to make a first home withdrawal in the next few years, your investment timeframe will be very different to that of someone in their late 40s who owns their own home, and for whom KiwiSaver is only part of their overall investment strategy for retirement. First home buyers needing ready access to KiwiSaver for their deposit might consider looking at a more conservative investment mix, less susceptible to an ill-timed dip. Then once they’re in their first home and are essentially starting again from scratch, they might adjust their settings to embrace higher risk funds with a longer investment horizon.

Depending on your timeframe, a specialised investment opportunity that carries higher potential risks and returns could have a role to play within a diversified portfolio which may include other types of investment such as property, a business, local and global equities, and so on. Within our portfolio of funds at Nikko AM, this could be the ARK fund, which focuses solely on Disruptive Innovation investment.

2. What Other Investments Do I Have?

This is the (financial) theory of relativity – your ability to withstand volatility based on the size of each type of investment, relative to your total assets.

Let’s say you see your equity-heavy $100,000 KiwiSaver halve in value due to market volatility. If you hold a balanced rental property portfolio, own a business and have cash assets, this is still a blow, but it’s one from which you’ll recover because it’s just one portion of your wealth. If, on the other hand, you are already stretched in managing your investment property interests and that KiwiSaver account is your main asset, it’s a much bigger setback.

If KiwiSaver is your entire retirement saving plan, you might want to make sure it’s well diversified across different funds and strategies. But if it’s a small portion of your total retirement plan, you may want to make room for a more aggressive fund.

3. What Is My Personal Risk Comfort Zone?

Your own level of comfort with risk is important, regardless of your timeframe and investment mix. This will be influenced by your material and mental capacity to withstand price fluctuations and losses.

For example, if day-to-day price movements in your investments keep you awake at night, then a diversified portfolio of assets that experience smaller price movements may be the best approach to give you a higher degree of comfort. The flipside is that, over time, this more cautious approach is likely to (but may not necessarily) lead to lower overall returns.

From a portfolio management perspective, the argument still holds that diversification will help you optimise your risk even within a lower-risk group of assets. For example, if all you want to own is term deposits, having these set up with different maturities with different providers will provide you with a more optimal risk profile than having everything in one term deposit in one bank.

Rethinking Your Approach To Risk

In general, investing in the things you’re interested in and know something about, will help you stay engaged with your portfolio and motivate you to keep up with your contributions. I’d imagine this is what has drawn you to the residential property investment market. With equities, you don’t have to be “all-in” with a fund that may pique your interest, such as the ARK fund. Rather than the main ingredient, this could be the spice that keeps your portfolio interesting.

When using diversification as a strategy to optimise risk, it’s important to align your investment approach with your savings goals. For example, a portfolio with a very high proportion of cash may keep you safer from losses, but it is unlikely to give you the gains you want. When you’re exchanging one measure of risk for another, be mindful of the danger of the lost opportunity. You’ll never make money off the investments you don’t make!

The Hallmarks Of An Optimised Investment Strategy

No investment strategy can ever be guaranteed 100% failsafe. But there are some simple tactics and techniques you can employ to remain focused on achieving your investment goals.

• Contribute regularly and steadily at an amount you can afford.
• Align your investment mix to your goals, timeframe and comfortwith risk.
• Maintain a long-term view.
• Consider making subtle incremental changes as your life changes.

If you’re worried that you don’t have the right diversification across your investments or KiwiSaver, or that you’re not optimised to succeed, don’t panic – it’s easy to change. Chat to a financial adviser about this, or as a first step you could always head to GoalsGetter.co.nz to see how your current investment strategy, risk profile and savings goals match up.


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