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When it comes to portfolio construction no single asset class will consistently outperform all other assets all the time.
To minimise potential losses and smooth investment returns over the long term, you should spread your portfolio across various investments. This is easier said than done as there many ways to diversify.
Diversify across asset classes
Asset classes are the broad categories of investments and include equities, fixed interest, property and cash investments. Equities include both Australian and international shares. Fixed interest includes government, semi-government and corporate bonds. Property includes residential, retail and commercial properties. Cash includes term deposits and at-call cash accounts.
Lower risk asset classes, including fixed interest and cash, protect your capital during adverse market conditions. On the other hand, higher risk assets such as Australian and international shares, can deliver strong returns during the boom times. Holding a mix of asset classes may help to provide more stable returns over the medium to long term as markets rise and fall.
The benefits of diversification
A properly diversified portfolio can help investors:
- Reduce exposure to individual investment failures
- Improve consistency of long-term returns
- Reduce overall portfolio volatility
- Protect capital during market downturns
- Support smoother investment outcomes over time
Diversification is particularly important during periods of market uncertainty, where different asset classes often perform in different ways.
Over time, markets are unpredictable. Some years shares outperform strongly, while in other periods defensive assets provide stability.
Diversification helps ensure that an investor is not overly exposed to any single outcome. This makes it a critical foundation of long-term wealth creation and retirement planning.
Rather than trying to predict which asset class will perform best, diversified investors accept that unpredictability is constant and structure portfolios accordingly.
Many investors unintentionally reduce the effectiveness of diversification by:
- Holding multiple similar funds that overlap in holdings
- Concentrating too heavily in one asset class (often shares)
- Ignoring international exposure
- Failing to rebalance portfolios over time
- Chasing recent performance rather than maintaining balance
Avoiding these mistakes can significantly improve long-term outcomes.
Building a diversified portfolio involves:
- Understanding your risk tolerance
- Selecting an appropriate asset allocation
- Choosing investments that complement each other
- Regularly reviewing and rebalancing holdings
- Avoiding unnecessary duplication across products
While simple in concept, effective diversification often benefits from professional advice to ensure alignment with personal financial goals.
A simple example of diversification might include:
- 30% Australian shares
- 30% international shares
- 20% fixed interest
- 10% cash
- 10% alternatives or property exposure
This structure aims to balance growth assets with defensive assets to help manage risk across market cycles.
The right mix will depend on an investor’s:
- Time horizon
- Risk tolerance
- Financial goals
- Income needs
While diversification is essential, too much diversification can dilute returns and make portfolios harder to manage.
Excessive diversification may lead to:
- Overlapping investments across funds or ETFs
- Higher fees without meaningful risk reduction
- Difficulty tracking overall portfolio performance
- Reduced impact of strong-performing assets
The goal is not to own everything, but to build a balanced portfolio where risks are spread efficiently.
Investment markets move in cycles, and no single asset class consistently outperforms over time.
Diversification helps reduce the risk associated with individual companies, industries, or sectors. By spreading investments across a broad range of exposures, investors reduce the likelihood that one poor-performing investment will significantly impact their overall portfolio.
For example:
- A downturn in the share market may be offset by stronger performance in bonds
- Weak performance in one sector may be balanced by gains in another
- International diversification can reduce reliance on domestic economic conditions
This smoothing effect is one of the key benefits of diversification over the long term.
Diversify within asset classes
This could mean spreading your share portfolio across different industry sectors because certain sectors may outperform others over a given period according to economic conditions.
Two good examples are mining and manufacturing. The Australian resources industry helped keep Australia’s economy a shining light against a gloomy international backdrop following the Global Financial Crisis. Manufacturing, on the other hand, struggles with high labour costs making Australia less competitive against low income countries such as China. Nobody knows what the future holds - both of these industries are facing volatile conditions a few short years later - so a balance across industries is crucial.
It can be simple
Even with a relatively modest amount to invest and very little time, you can construct a fully diversified portfolio with the right mix of investments.
Managed funds offer easy access to a wide range of investments. By investing in a managed fund, professional fund managers select individual investments for you. In addition, most managed funds offer several different options to cater for varied levels of investment risk.
Other options include purchasing shares in Listed Investment Companies (LICs) and Exchange Traded Funds (ETFs) on the stock exchange. Depending on its charter, a LIC holds shares in a wide range of companies, while ETFs invest across all stocks making up a particular index, such as the S&P/ASX 200. Buying shares in an ETF or LIC gives you exposure to all the stocks held by the fund.
FOR MORE INFORMATION
If you would like to learn more about the topics discussed in this article, please contact your local financial services' specialist.
Note: past performance is not an indicator of future results.
This page has been prepared by RSM Financial Services Australia Pty Ltd ABN 22 009 176 354, AFS Licence No. 238282.
As everyone's circumstances are different and this article doesn't take into account your personal situation, it is important that you consider the above in light of your financial situation, needs and objectives, and seek financial advice before implementing a strategy.
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Diversification is one of the most effective ways to manage investment risk, but every portfolio should be tailored to your personal objectives. Our advisers can help you create an investment strategy designed for long-term success.
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Ready to review your investment strategy?
Diversification is one of the most effective ways to manage investment risk, but every portfolio should be tailored to your personal objectives. Our advisers can help you create an investment strategy designed for long-term success.
Speak with an RSM Financial Adviser
