Securing a financially free future
An often sought after financial goal is to achieve financial freedom. Who would not want to be wealthy enough to have a financially secure future?
Yet, financial freedom does not come around by accident. Being financially free takes a whole lot of discipline and some bit of know-how. Putting aside little amounts of your savings over the long term makes a significant impact to achieving your financial goal. The sooner you start, the sooner you become financially free. The more disciplined you are about this the better is your chance of success.
When it comes to know-how, diversification is a strategy that is critical to building a savings pot for the future.
Spreading your chance of success
Diversification simply means not having all your eggs in one basket. That is to say, avoid having all your money invested in the same thing, in the context of financial planning. For instance, you may be convinced about the prospects for retirement village operators. On that basis, you then invest ALL your savings into the shares of one of the businesses in the sector. If you had a guarantee that the particular business was going to be a winner, it should be fine.
Unfortunately, when it comes to investing there is always an element of risk. The risk being that the outcome you are expecting does not eventuate, or in other words, you suffer a financial loss.
Protecting your portfolio from large losses is imperative to achieving your long-term financial goals.
Dealing with an unpredictable future
Investment risk can arise for a number of reasons. As per your determination, the business you have chosen to buy shares in may very well be well run and set for fantastic growth into the future.
But, a change in legislation or a sector wide issue impacting all businesses in that sector can drag its prospects down at any time. Alternatively, issues in the wider economy locally or globally can mean that your shares lose value.
Risks of this type are referred to as being ‘systematic’. Meaning, risks to the wider “system” or in this context, it refers to the general investment climate. Systematic risks are harder to avoid. Risks emerging may also be specific to a type of financial asset. When shares are falling in value, the prospects for bonds may be looking more favourable.
Why is this important for growing your investment portfolio over time?
A well-diversified portfolio will have a mix of different assets. It will have some amount of shares, some bonds, some in a call account, some in property etc. The idea being that, should one of these types of assets perform badly the others in the portfolio should compensate for that. As a result, your overall investment portfolio may not suffer from large losses.
Tips on diversifying
The idea then is to have the right mix of the different types of assets you are able to invest in. Different types of assets perform differently through market cycles. The more the individual assets vary from one another over time, the safer your investment portfolio is likely going to be.
Remember, if your investment portfolio includes managed funds, (such as KiwiSaver funds) you should look through to see what types of assets the fund is invested in. From the perspective of diversification, you should consider investing your non-KiwiSaver savings in assets that are not in your managed funds holdings.
As an overarching principle, consider having more stable assets such as bonds and term deposits in your investment portfolio as you grow older and near your horizon for a financially free future.