What does diversification mean?
They say you shouldn’t put all your eggs in one basket. It is the same in investing and it is called diversification.
Portfolio diversification will lower the risk of your KiwiSaver because not all asset categories (e.g. equities and bonds), industries, or shares move together. This decreases the volatility of the portfolio because different assets will be rising and falling at different times, smoothing out the returns of the portfolio as a whole. It reduces the risk that one investment doing badly, e.g. a company going bankrupt, will materially affect the overall performance of your KiwiSaver.
Diversification also improves the return relative to the risk of the portfolio. If you can lower your risk without sacrificing too much in returns, it is a good deal.
At kōura, we diversify your KiwiSaver investments in several ways: by having portfolios with different asset classes (i.e. equities and bonds) and diversifying the investments within these asset classes:
Diversification within asset classes:
- For your overseas equity investments, we use index funds which hold over 3,000 companies in 40 countries. This means we are not materially exposed to the economy of one single country or to any specific company.
- For your NZ equity portfolio, we invest in the 40 largest NZ companies, but we cap any single company to 7% of the portfolio to reduce the risk of any single company.
- Your fixed-income assets are invested in a range of bond issuers ranging from the New Zealand Government to high-quality NZ companies and banks.
Diversification between asset classes:
- Mixing equities and bonds in a portfolio reduces risk by a greater amount than the weighted sum of their individual risk or volatility because the price of equities and bonds are not correlated, i.e. they don't move together at all. In fact, they have been historically inversely correlated, i.e. one went up while the other went down, although this is less the case now.
- At koura, we recommend that you have a lot of equities when you are young because higher returns with more risk is a better tradeoff if you are far away from needing the money. When you get older, reducing risk become more important and we adjust the portfolios to take advantage of the lower risk associated with diversification.