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Diversification

Diversification simply means not putting all your eggs in one basket. This means ensuring that exposure to one asset class, or one security in a particular asset class, does not distort the balance of your overall portfolio. Modern investment planning (portfolio) theory has clearly shown that investing in a range of securities across a range of investment classes lessens the risk of investing. The principle of protecting the downside maximises gains over time.

For example for each $100 invested which loses $50, you must earn 100% on the $50 remaining to get back to where you started. If $100 invested lost $10 you must earn 11% to get back to $100. This is very much like the story of the tortoise and the hare.

This principle is based on the fact that investment markets do not all move in the same direction at the same time. They move in cycles and will behave in different ways under different economic circumstances and climates.

The different classes of investment are:

  • Cash
  • Fixed Interest
  • Property
  • Shares

Each class has a domestic and an international element. By spreading investments across the classes both domestically and internationally provides diversification across the different asset class cycles.

Historical Returns

Historical evidence based on United States' statistics between 1926 and 2006, shows a clear difference in returns achieved by the various asset classes. After inflation these compound annual returns have been:

Cash 0.7%, Fixed Interest 2.2%, Shares-Small Companies 9.3%, Large Companies 8.1%. 

(Source: Ibbotson Associates, 2006 Yearbook)

IPAC Securities (NZ) Ltd estimate the expected annual compound long term real returns to be:

Cash0-2%Fixed interest1-3%Property (commercial)3-5%NZ Shares5-8%

Projected Returns

Conservative

Assuming an after tax and after fees return of 4.5% p.a. an initial $10,000 would grow to $15,530 over 10 years, $24,117 over 20 years and $37,453 over 30 years.

Moderate Assuming an after tax and after fees return of 5.5% p.a. an initial $10,000 would grow to $17,081 over 10 years, $29,178 over 20 years and $49,840 over 30 years.

Aggressive Assuming an after tax and after fees return of 7.0% p.a. an initial $10,000 would grow to $19,672 over 10 years, $38,697 over 20 years and $76,123 over 30 years.

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