Unlocking the full power of diversification

There is more to diversification than just a tool to avoid putting all your investment eggs in one basket.

While diversification is a highly effective capital protection mechanism – particularly for those nearing retirement - it can also be a powerful tool to facilitate the achievement of sustainable investment growth.

“While diversification is correctly viewed as a loss limiter, there is actually far more to it than merely spreading out your investments so that negative performance by one share or asset class doesn’t spell complete disaster for your retirement investments,” comments Melissa Dyer, Head of Retail Channel and Product Marketing at STANLIB.

Facilitating growth

According to Dyer, an effective diversification strategy is one that not only limits the potential risk of overall investment capital loss, but also allows for, and indeed promotes, continued portfolio growth within clearly defined risk parameters.

“In order to achieve this kind of risk-limiting, growth-facilitating diversification, investors need to understand how asset classes tend to behave over time and how best to combine the most appropriate assets in line with their unique objectives, time frames and risk propensity – which is where access to specialist knowledge and the services of an advisor who understands diversification is invaluable,” explains Dyer.

More than meets the eye

There is also more to diversification than just spreading your retirement investments across asset classes. “These days, the well-diversified portfolio is one that not only incorporates cash, equities and bonds, but also spreads risk across countries and currencies,” says Dyer. “While this can be a daunting undertaking, the risk management and growth opportunities that an appropriately diversified portfolio offers more than make up for the effort involved in putting it together.”

Retirement investors

Paul Swanson, Portfolio Manager, Balanced Funds at STANLIB agrees. “Diversification not only allows investors to effectively manage their risks of capital loss, but also, when done correctly, it can actually be a very cost-effective way of delivering positive growth right up to retirement age.

“While protecting your capital is of utmost importance as you near retirement, that doesn’t necessarily have to be at the expense of returns. By including a selection of tailored, cost-effective funds in a retirement portfolio, one can reduce the risk of capital loss while, in many cases, enhancing the potential for continued above-inflation returns.”

Both Dyer and Swanson are adamant that regardless of the reason for diversifying their portfolios – whether to limit losses, facilitate steady growth, or a combination of both – those who are saving towards their retirement simply have to make effective diversification a key part of their investment approach.

Paradigm shift

Swanson explains that retirement investors and their financial advisors need to undergo something of a paradigm shift when it comes to the reasons for diversification as part of an investment approach.

“While it’s certainly not a ‘silver bullet’ that is guaranteed to keep your retirement nest egg unscathed during times of global economic turmoil, the experience of investors during the recent financial crisis left no doubt as to the power of diversification as an effective investment management tool,” adds Dyer. “Retirement investors that fail to harness that power in their own portfolios are not only missing out on the opportunity to secure cost-effective growth, they are also placing their financial future at significant risk.”