Because many elements that impact your investments are out of your control, it makes sense to do what you can to reduce your risk.
One of the main ways to do this is by building up a portfolio of different types of investments that includes defensive and growth assets.
Defensive and growth strategies
The priority of a defensive asset, such as a savings account or a term deposit, is to earn regular interest payments while preserving the money you already have.
Growth assets on the other hand, which include shares and property, have the potential to deliver much stronger returns over time – albeit weighed up against the risk of much larger losses.
For this reason, many investors aim to put their money into several different asset classes in order to protect their savings while also growing their overall wealth. This strategy is known as diversification.
Exactly which assets you choose and how much money you invest into each will depend on your stage in life, how long you want to stay invested for and your appetite for risk, among other factors.
Where to invest
Sometimes it’s tempting to put all of your money into a strongly performing investment – whether it’s some shares that are growing particularly fast or property in a suburb where prices are rising quickly.
But think about it this way. What happens if the company that was growing so rapidly suddenly announces its profit has fallen and its share price starts to decline? As a shareholder, this situation is far less scary if you know you have only a portion of your money invested in that one business.
While property prices are usually less volatile, they can still fall, particularly if you have bought into an area where infrastructure and amenities like schools and shops are yet to be established.
By spreading your money across different investments, you’re likely reducing the risk of your whole portfolio underperforming simultaneously.
Over time, this approach should help set you up to achieve a more consistent rate of return, with losses in some investments potentially offset by the gains in others.
Different ways to diversify
While it is one approach, diversifying doesn’t necessarily mean you have to buy several different types of investments. There will probably always be some assets that suit your needs better than others.
For example, if you’re young and happy to take on a bit more risk in order to have a better chance of growing your wealth, you may like the idea of investing more of your money in shares.
By buying into a number of different companies or industries, or investing in different managed funds, you can still create a portfolio that doesn’t leave you too exposed if one or two of your choices don’t perform as well as you were expecting.
Don’t be put off if you’re only starting with a small amount. You can still get started with a single investment, but you have the opportunity to think about risk and return from the outset and work towards building up a diversified portfolio over the long term.