This guide explains general concepts for educational purposes. It is not financial, tax or legal advice, or a recommendation to buy, sell, hold or change a financial product or strategy. It does not take into account your objectives, financial situation or needs. Rules, caps, thresholds and product terms can change. Check the current official information and obtain advice appropriate to your circumstances before making a financial decision.
Different assets behave differently
Diversification aims to reduce the impact of a poor result from one investment, sector or market. A genuinely diversified portfolio usually spreads exposure both across and within asset classes.
Holding more investments is not always more diversified
Several funds can own many of the same underlying securities. Concentration can also arise through employment, property, currency or a large holding in one company. Look through product labels to the actual exposures.
Diversification manages risk; it does not remove it
Broad market falls can affect multiple assets at the same time. Diversification may reduce volatility and concentration risk, but a portfolio can still decline in value.
Several layers of diversification
Asset allocation spreads a portfolio across broad investment areas. Diversification within an asset class can spread exposure across companies, industries, countries or issuers. These layers address different kinds of concentration and are considered together when describing a portfolio.
Several funds can still hold many of the same securities. A portfolio may also have an indirect concentration through employment income, a business or property outside the investment account. Looking at the whole financial position gives a fuller picture than counting accounts or fund names.
Why the mix changes
As investments produce different returns, their proportions in the portfolio change. A strong-performing area can become a larger source of risk than it was originally. Rebalancing describes bringing the allocation back towards an agreed mix; it is distinct from predicting which investment will perform best next.
The timing and method of rebalancing can involve transactions, costs and tax consequences. Contributions or withdrawals can also change the mix. The role of diversification is to manage reliance on particular outcomes, while recognising that broad market falls can still affect several parts of a portfolio at once.