The average Australian investor’s portfolio is shockingly overconcentrated. While things are changing, typically the top holdings – including in superannuation, where many people are unwittingly invested – look something like:
Commonwealth Bank of Australia (ASX: CBA)
Westpac Banking Corp (ASX: WBC)
Wesfarmers Ltd (ASX: WES)
Woolworths Limited (ASX: WOW)
BHP Billiton Limited (ASX: BHP)
Fortescue Metals Group Limited (ASX: FMG)
Telstra Corporation Ltd (ASX: TLS)
You get the idea. This is a concern because research shows that holding somewhere between 12 and 20 different stocks provides a significant amount of protection in the event of a downturn – as long as the businesses held are themselves diversified.
Put simply, if you own all four Big Banks, they are each vulnerable to identical economy forces and a downturn will wreck all four. Likewise, with BHP and Fortescue Metals Group, their biggest risk is the price of commodities, which is driven by China. If you own this combination of shares, you are concentrating your risk, not diversifying it, which means you will suffer worse in a downturn.
There are a growing number of tools like exchange traded funds that allow investors to achieve diversification at a lower cost, plus many brokers now offer international brokerage, giving further opportunities for diversification.
Instead of owning the above businesses, here are a few that may offer greater diversification benefits:
Cochlear Limited (ASX: COH) – global developer + maintainer of hearing aids
CBL CORP FPO NZX (ASX: CBL) – global construction insurer with major operations in France
QBE Insurance Group Ltd (ASX: QBE) – global insurer with operations in multiple countries
CSL Limited (ASX: CSL) – global healthcare and biotechnology company with operations in USA
Beta Cyber ETF Units (ASX: HACK) – an exchange traded fund (ETF) offering low-cost exposure to leaders in global cybersecurity business
While each of these businesses may still fall in a market crash, their earnings are likely to be far less at risk in the event of other upsets – such as an Australian property collapse or a Chinese debt collapse.
To be clear, you should never buy a company you don’t understand just for the sake of being ‘diversified’. But if the alternative was being shockingly overexposed to a couple of major risks, I’m not sure that’s any better. Investors should always ask themselves what the biggest risks appear to be, consider how much of their portfolio is exposed to these risks, decide whether they are comfortable with these risks, and then act accordingly.
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Motley Fool contributor Sean O'Neill has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of Telstra Limited, Wesfarmers Limited, and the Betashares HACK ETF. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.