How to build a diversified investment portfolio

Spreading investments across different asset classes minimises wealth-management risks and is a proven way of delivering strong long-term financial returns.
There are some golden rules in the world of investing – and one of them is ensuring you have a diversified investment portfolio.
Experienced financial advisers urge their clients to have a balance of assets such as property, shares, bonds, cash and private equity as part of a sound wealth-creation strategy.
Darren Spencer, Lead Investment Director, Mercer Australia, says diversification is a proven way of delivering long-term financial returns, and limits negative exposure to any single asset or market segment. By contrast, if you put all your eggs in one basket and the market crashes, you can suffer significant financial losses.
“The way I describe portfolio diversification is that it’s one of the bedrocks of building wealth because if you're not diversified you can experience a wide range of outcomes – and those outcomes can be very good or very bad. But you can’t consistently generate a good investment outcome with a non-diverse portfolio.”
Get a spread of asset classes
The chief asset classes that typically dominate a diversified investment portfolio are shares, cash, property and fixed-interest assets such as bonds. In addition, it can pay to have exposure to private equity funds that invest primarily in unlisted companies, real estate and infrastructure.
Although most investors are familiar with shares and property, they may be less well-versed about bonds. They are fixed-income instruments whereby investors provide capital to borrowers such as corporate or government entities. While they are not seen as ‘glamorous’ assets, bonds are ideal for investors with a low-risk appetite because, when held to maturity, they can offer stable and consistent returns.
Spencer likens bonds to the “ballast” in times of market turbulence, whereas equities typically drive long-term returns to fund retirement. “Without equities, you're not going to enjoy the benefits of compound interest. But, when it's all said and done, you need to be in a position to build a diversified portfolio that's going to give you the best chance of meeting your desired investment objectives and outcomes.”
Understand the ups and downs
For pre-retirees or older people, in particular, a diversified portfolio can provide peace of mind and protect all-important savings.
Spreading your investment across multiple assets provides a form of insurance in case one performs poorly. History points to consistent trends in investment portfolio performance depending on a range of economic and geopolitical events. For example, equities tend to perform well in high-growth markets, and they often outperform during times of high growth and low inflation.
When growth is muted and inflation is low, defensive assets such as bonds are seen as a safe option. In more challenging markets when growth is low and inflation rises, cash and relatively solid assets such as real estate may come into favour.
The key point is that no asset class tends to be best in all market conditions, so investors should diversify their portfolio over the long term to ride out the highs and lows.
You can also diversify within each asset class. For example, when buying shares it makes sense to target a range of different sectors, such as banks, resources companies, healthcare organisations and tech and energy stocks.
Spencer also advises having a mix of capitalisation ranges, rather than just chasing the top 100 companies, for instance. “There are also really good companies in the mid-cap and small-cap area as well,” he says. “Making sure you’ve got those covered off is a good idea.”
Investors are also well advised to explore opportunities to invest in international markets. Spencer notes that the Australian market represents just a small percentage of overall global equity markets. Investing overseas can lower the risk of investing in a single market and provide access to blue-chip companies outside Australia. “Amazon's a good example, as well as Google, Apple and Microsoft – all of those top-tier kind of technology companies,” Spencer says
Protect your retirement dreams
As part of creating a diversified portfolio, it makes sense to do an analysis of any current assets and to assess new opportunities.
This is where specialist advisers can come to the fore. Experienced financial advisers can maximise the chance of stable financial returns and minimise downsides. It is their job to assess and understand a client’s objectives and then structure a portfolio around that risk profile.
Risk profiles and goals can differ markedly from person to person, depending on income levels and lifestyle and retirement goals. Spencer notes that financial entities such as Mercer Super can draw on well-established global investment teams. “Through our global network of investment professionals, we’re in a really good position to identify investment opportunities, research those opportunities and then provide access to them in an investment portfolio.”
He adds that advisers can help people navigate often complex financial considerations, especially in the case of retirees, who can pay a heavy price if they focus on one area of the market and it then experiences a major downturn.
Spencer warns of the danger of “sequencing risks” when negative market returns occur late in a person’s working years, or early in retirement. “That’s money that’s not coming back. So, you've got to be in a position where you can have an appropriate mix of assets, whether it be bonds, equities, real estate or infrastructure. And by doing so, you reduce the volatility of your total portfolio.”
The bottom line is that investing should be as stress-free as possible and rewarding. By taking a disciplined approach and using diversification – with some input from an experienced adviser – it is possible to invest strategically and successfully.
Discover how Mercer can assist you
To find out more about wealth management and structuring your investment portfolio, speak to your Mercer Financial Adviser.