Why diversification is so important right now
Ever heard the saying “Don’t put all your (nest) eggs in one basket”? Let this be your investment mantra – especially during times of market volatility.
Diversification is always critical to investing, but never more so than in times of market uncertainty. While it won’t eliminate investment risk (in fact, nothing can), diversification is about spreading your money across different investment types – so you can enjoy a smoother ride.
In other words, market volatility is outside of your control, but you can reduce volatility in your portfolio. And here are some key things to consider.
In this guide, we’ll look at:
Why you can’t time the market– As tempting as it may be, timing the markets to avoid volatility is impossible; rather than fleeing investment risk, diversification can help you manage it.
Some lessons from past ‘market darlings’ – As these success-stories-turned-sour show, volatility can happen anytime, anywhere.
The importance of diversifying across companies and regions – An all-encompassing diversification strategy, based on your needs and goals, can help you minimise wild swings, including those in your KiwiSaver plan.
You can’t time the market
“It’s about time in the markets, not timing the markets”: here’s another good investment rule to remember. When investment markets are bumpy, it can be tempting to try and ‘time the market’ to avoid volatility. But you can never predict where markets are headed next; no matter if you’re a seasoned investors or you think you know investment trends like the back of your hand.
The key thing is not to ‘hide’ your money from investment risk – which is plain impossible – but embrace it and turn it into opportunity. And diversification can help you do just that.
Some lessons from past ‘market darlings’
To illustrate the importance of diversification in times of volatility, let’s have a look at some ‘market darlings’ we’ve seen in the past few years. Their troubles are a cautionary tale of how past performance is never indicative of future results.
Facebook was one of the big ‘Covid winners’ and, until September 2021, one of the largest companies in the world. But since then, things took a steep turn south.
In February 2022, shares of Facebook’s parent Meta lost more than US$231 billion in value in 24 hours. It was the biggest one-day drop in the history of the US stock market, topping the prior record set by Apple in September 2020 (US$182 billion).
And this phoenix is yet to rise from the ashes. From the start of 2022, Meta has shed about 70% of its value(1). More recently, Meta reported that profits had halved during the third quarter, and investors responded by wiping another US$80 billion off the company’s market value.
So, why is Meta in a financial free-fall? It looks like investors and consumers are not sold on the company’s focus on creating a ‘metaverse’, the virtual-reality environment that’s supposed to revolutionise the Internet – with many seeing it see as little more than a money pit. Meanwhile, users are jumping ship and advertising revenue is way short of expectations. To be back in investors’ good books, Meta have some hard work ahead of them.
Just like Facebook, Tesla is traversing uncharted waters. Earlier this year, the company seemed almost invincible, sending the media scrambling for explanation. By April 2022(2), Tesla had only dropped 7.5% year-to-date (in line with the S&P 500), and had even posted a record quarterly profit of US$3.3 billion in Q1 2022.
But soon after, Elon Musk’s lucky star was done shining. In October 2022, Morningstar(3) reported that Tesla’s stock was down nearly 50% from its November 2021 peak. Essentially, the company had given back all its 2021 gains, with much of the decline happening in the previous few weeks.
While Tesla blamed subdued revenue on rising production and distribution costs, it appears that Musk’s Twitter saga has also alienated investors. As Morningstar pointed out, the news that Elon Musk would go ahead with the purchase of the platform had come as a shock to the markets, amid concerns that he might have to sell Tesla shares to fund the US$44 billion Twitter deal(4).
What’s more, the Twitter distraction is not the only issue facing Tesla. As investment manager Jim Chanos put it, referring to Tesla’s annual unit sales target, “it’s really, really hard to be a luxury car manufacturer and keep growing 40%, 50% units.”(5)
Markets can be equally volatile
It’s not just individual shares that can be volatile, but entire markets as well. In the ‘80s and early ’90s, for example, Japan was everyone’s favourite market in the world and money poured in. Analysts thought it was only a matter of time before the Japanese share market and even the country’s economy overtook the US. But we all know the end of this story.
The ‘90s went down in history as Japan’s ‘Lost Decade’, largely caused by rampant speculation, record-low interest rates, and inflated real estate valuations throughout the ‘80s. Once the Bank of Japan started raising interest rates again to stem the speculation, the house of cards quickly crumbled to the ground, as borrowers struggled to repay debts on speculative assets.
In 1992, the asset price bubble burst and over the following seven years the market plunged, losing almost 70% of its value. It ended up being one of the longest-running economic crises in financial history, as the Japanese market didn’t fully recover until early 2021.
That’s why we diversify across regions and across companies
These are just a few notable examples; the history of investment markets is punctuated by success stories that turned sour before recovering again. It just goes to show that these events happen, and it’s just impossible to pick when they might occur.
As we’ve seen, it’s not just individual investments or assets that go through cycles, but also whole markets can get caught up in periods of temporary euphoria and progressively divorce from reality.
That’s why it’s important to diversify across both regions and companies. The goal is to spread your money around by investing across a wide variety of regions, sectors, and asset classes, depending on your needs and goals. In the same market conditions, some investments perform well while others not so much. So, having a wider exposure helps ensure that bad returns from one asset are offset by the returns of other assets.
Once again, it’s about not putting all your eggs in one basket – especially when the basket can be upended any minute.
How diversified is your KiwiSaver plan?
You can use our digital advice tool to check what your KiwiSaver plan is on track to give you, and the recommended portfolio composition for your risk profile, needs and goals. Our kōura personalised portfolios have been developed using a proven portfolio allocation theory, to reduce risks while maximising returns – click here to learn how it works.