Uncensored Money Season Three: Understanding Diversification and Risk When Investing
Melissa Browne: Ex-Accountant, Ex-Financial Advisor, Ex-Working Till I Drop, Now Serial Entrepreneur & Author, Financial Wellness Advocate, Living a Life by DesignĀ | 20/12/2022
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Show Notes
When it comes to investing, diversification is critically important. So in this episode, Mel and Lawsie explain what it means and steps you can take to achieve it.
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Transcript
Mel: I don't know about you, but I think most people are cautious of risk, particularly as you get older. I know that when Tony and I went to Niseko in Japan skiing quite some time ago, there were these young kids and they would've been, oh gosh, they were as high as my knee, I'm sure. So there would've been less than five.
They were just tearing down the slopes in a little line because they've never experienced necessarily a broken bone. They haven't experienced anything traumatic necessarily. So for them, it's all fun. Whereas I'm going down thinking, oh God, I'm a klutz. My knees are dodgy. My ankles are dodgy. If I fall, it's gonna hurt. I've already fallen 20 times. My butt's bruised. So it's something that you tend, as you get older, your ability to cope with risk will go down for most people. Lawsie, what about you? Is that something that you experience of when you were younger compared to now?
Lawsie: Oh, I think I say it more even with like my niece, cause in the last six or 12 months she's been learning to ride a bike. And you just watch them like they've got their tiny little wheels and yes, they fall off all the time cause she's just learning, not with training wheels or anything, she's just, off I go on a little balance bike thing and you see her just fall off all the time and they just get up and they just keep going And now she's so confident on it and she just flies down the hill and she's yelling at me to be chasing her. No, like I'm very happy riding my bike. I do not love going downhill. And it's that whole thing again, because of the risk. I know the consequences if I come off and break every bone in my body and the cost of breaking said bike and all of these things. But it's really funny when you look at and go, I'm significantly older than you and feel like I should be able to keep up with you riding down. Nope. No chance, because she just has no fear. She just hasn't lived enough, I guess, to understand the consequences of what could go wrong. So it is just living in the moment for it. Whereas we've all got those million thoughts going through our head going, no, no, no. Abort, abort, abort. Or just do it and do it really cautiously.
Mel: Yeah.
Lawsie: So yes, I would definitely agree with it. We perceive risk slightly differently once we're older.
Mel: But I would even say like even in my twenties compared to now. So I remember, and this was a judgment in being younger as well. I remember a girlfriend and I after the races we were out at a bar and we got talking to the security guard and his girlfriend and they said, oh, we are going to another club. Why don't you just come with us? I went, sure, you are really lovely. We got out of there and got in the back of his white van. Well, which I mean is every horror movie ever? And I remember there was a moment where I'm looking and going, should we be here? Is this going to end well?
But it's that whole being cautious because there is no way I would do that now. No way. But I think part of it is being sensible, but part of it is simply because we now understand risk versus rewards or risk versus pain
Lawsie: Yeah
Mel: Risk versus loss perhaps. And when it comes to investing, whether times are uncertain or not, it's so freaking important to have diversification. And part of that is because of risk. Now, you've probably heard of the term, don't put all your eggs in one basket. And when it comes to investing, that is how we mitigate risk. All that not putting your eggs in one basket or diversification means when it comes to investing is to invest across different asset classes and then to invest within asset classes.
So what are the different asset classes and the timeframe? So cash is the least risky. Timeframe for cash could be, I might need it tomorrow. Up to say three years. Cash might mean any cash on hand, cash in the bank or other accounts that can be readily converted to cash, but the risk is low. You know, for most people we're not talking cash under the mattress. We're talking cash in the bank. Exactly.
The next investment that is a little bit riskier is bonds. So bonds are also known as fixed interest. They are a debt instrument with a promise to pay back the money with interest. So essentially you are so the ones that are best known to government bonds. So you are giving it to the government. It's essentially a loan that they will then use that money and they'll pay it back with interest. So yes, it could be risky. We've all heard of economies collapsing. In Australia, I would argue that it's less risky a government bond, but you can still get corporate bonds and other bonds.
So risk is low to medium. The return is your interest, again, which is guaranteed and your timeframe, again, would be that short term, so maybe one to three years or even five years.
The next one is real estate. So property can be either direct or indirect investments across residential or commercial. So direct simply means I own the property, I can walk up to it, touch it, feel it. Indirect might mean it's a property trust that I've bought on the stock exchange where I own a unit in a unit trust and that trust owns maybe commercial property or industrial property. So the risk is medium to high, which is interesting cause I wanna suggest that in Australia we don't think of property as a risky investment.
But it is, it's a medium to high risk. So the return, if it's your home, it's nothing, but if otherwise, it's rent. But it's also the growth or the loss. So the property going up or down in value, which is where your home if you're prepared to sell it, would give you a return your timeframe. Experts say the timeframe is five plus years. I wanna suggest it's more like 10 plus years, cause the cost of purchasing property the exit and entry costs is so large that you want a much longer timeframe to recoup at least those costs, and then some.
And then the final one is shares. So shares which are also known as equities or stocks, all the same term for the same thing, are used to describe units of ownership all in one or more companies. And in here you can also put in ETFs, exchange traded funds and managed funds where you're not owning the share themselves, but you're owning units in something that's buying shares.
Now the risk for that is considered high, and that's because of the short-term liquidity meaning they'll go up and down a lot potentially in any given day. Return is your dividends and your growth and loss, and the timeframe is five plus years. I wanna suggest it's more like seven plus years, because again, you don't wanna put your housing deposit in there. You don't necessarily want to put your kids' education in there because if you need to grab those monies that are fixed at point in time and there's been a drop, that's where it could be problematic.
You could also get diversification across within those asset classes as well. So for example, with bonds, it might be a government bond and a corporate bond, or an insurance bond. With property, it might be commercial property or residential property. It definitely would not be property in the one suburb or the one street. And shares would be the same. So there are 11 different industries in the Australian share market. So it would be having a breadth across those different industries or looking at something like ETFs or managed funds, which give you instant diversification.
So that's kind of the broad brushstroke of diversity and risk. So Lawsie, I guess things that we see are people getting overexcited and wanting to jump in without thinking about diversification, about risk and we wanna talk about how you could potentially solve it.
And things to be aware in order to lower that risk, in order to not feel like you're jumping off the high rope or you're not getting into the back of the van with their nice security guard who might not have been so nice or pedalling down a hill wildly after your niece knowing that this is going to end badly.
So, shares Lawsie, how I've already briefly mentioned how you can, but how can you get diversification if I'm investing in the share market?
Lawsie: Yeah, look, there are lots of ways. I know you mentioned that ETFs or exchange traded funds can give you instant diversification. I would clarify with that. That it's making sure that the exchange traded fund that you are investing in is actually diversified. So an example of that would be if you wanted to invest in one of some of the top companies in the Australian stock market, then you could.
Mel: So the top 200 companies?
Lawsie: Yeah, so you could absolutely invest in an exchange traded fund that invests in the top 200 or 300 of those companies. So that is gonna give you that instant diversification and is gonna be easier than you sitting there, rolling the dice, going, oh, am I just gonna invest in BHP or ComBank or Telstra or whatever, direct shares that you're thinking of.
So that way you're getting exposure to obviously 200 or 300 companies. But you're also covering off on those different industries and sectors that you mentioned as well. So that's gonna be a way of doing it. Whereas if you just decided to go on a really specific niche, I don't know, US tech exchange traded fund like you areā¦
Mel: Like Spaceship, the app.
Lawsie: Yeah, like you're then really narrowing your investment and if that's the only thing you invest in, you're only giving yourself exposure to literally US tech shares.
And even if you wanted to invest in the US market, like it's a different country, different market, all of those things, which you might go, yeah, that's diversified cause it's not Australia. But again, if you're only doing tech, you're doing one narrow sector in and ignoring retail and banking and all the other sectors that exist. So I think exchange trade funds is where a lot of people go. Oh yeah, it's easy. And I don't have to necessarily think about it. I would say, you do need to think it.
Mel: Gives me instant diversification where you've just proved that it doesn't necessarily,
Lawsie: So it is being aware of that. But again, with shares, some people go, oh, I've got some BHP shares. And that's lovely, but again, you've only got shares in one company, which is in a particular industry. What about all of the others? And that's not to say that everyone has to have exchange traded funds. If you are going to do direct shares, look at a range of companies across a range of sectors. Again, just making sure that you've got that diversification. So if mining shares tank, but banking shares go up like that again is gonna help. It's helping balance out that risk.
Mel: And owning one share across each industry is not diversification. You might need a minimum of 10 shares per industry to give you some level of diversification, and then potentially depending on which you've chosen, it could be helpful or not. And most people don't necessarily have the funds, but that then means 200 shares or the wherewithal to have to deal with those, which is where a lot of people feel comfortable with something like an ETF for a managed fund, because it gives you more diversification.
But as Lawsie said, it might not just be one ETF, it might be a basket of ETFs across different sectors. It might be a mixture of direct shares, ETFs, and managed funds. So it's making sure you have diversification, not just thinking you have because the thing that you've bought gives you that perception that you have diversification when you don't.
Lawsie: And for some people, thatās awesome. Like they've taken that plunge and they've got their first investments. Yes, I've got these particular shares, and if that's you, then I think it's now like just being aware of this diversification piece and making sure that, okay, yes, I've got this particular share, or I've got this particular exchange traded fund, but doing that review and going, but is it actually diversified?
And then what else can I be doing over time? Like we're not suggesting that everyone's just got money sitting there that they can just throw it investing. But working out that plan where it's okay, my next step will be to buy A, B, C share or X, Y, Z exchange traded fund or put some money into that managed fund over there. So that you are just continuing to build that diversification and therefore help to reduce the potential risk within your share investments.
Mel: Yeah. And we are gonna talk at the end about some things that you can do if you are share-heavy or if you are industry heavy so that you've got some action items that you can do as well.
So that's shares. But if you're buying property, it would mean not simply buying your home at an investment property in the suburb or the street orā¦
Lawsie: Next door
Mel: ā¦the apartment complex next door, but rather diversifying across regions or types of property.
And when we were accountants and financial planners, we saw this all the freaking time. Someone would come in and they live in Glenbrook and they've bought their investment property in Glenbrook cause they understand Glenbrook or they live in the mountains and they've bought in the mountains cause they understand the mountains.
It can be really dangerous because you are then putting all your eggs in the Blue Mountains basket versus moving that to different areas. And I know some people will say yes, but I don't understand where I would invest otherwise, and I don't have the time or the inclination or the research.
So how do you solve that dilemma if someone hears that and goes, well, I hear you say that, and I wouldn't know where to start. So I'm tempted just to go to what I know, which is such a human thing.
Lawsie: Oh, absolutely. And I think it's also that thing where people go, there's that comfort in that. I can drive past it and it's easier to manage, but it's not to say that it's necessarily a great investment. Which is definitely where people can consider talking to buyers agents and property experts in that, because that is their job. In the same way that a Mortgage Broker's job is to help find you the best loan for your property or your loan or whatever you're doing. A buyer's agent is there to help you find a great property and you can use them for your own home. But more commonly people use them for investments for that exact reason where that you said before where they know they've heard and they've gone, all right.
I don't wanna buy the house next door, even though I'm tempted just to touch it and keep an eye on the tenants. But I don't know what's happening in Queensland or I don't know what's happening in Perth or Melbourne or Sydney or whatever else. So finding a buyer's agent that is qualified for starters, is an expert in that area. Because it's hard. No one can be an expert in absolutely everything, so I think it's just making sure that if you have narrowed it down to an area where you're thinking you'd like to buy, then finding a buyer's agent that is an expert in that area or there are still businesses that would exist that can help actually work with you to figure out and narrow down where, let's say in Australia or wherever you are located, where within Australia or where within New South Wales or whatever it is that you might like to buy.
And then they can put you in touch with buyers agents that actually specialize in that particular area because someone that specializes in Perth might have some great opinions on what's happening on the eastern seaboard, but are they going to necessarily be the best person to advise you on the right property and what's happening in the Sydney property market, for example.
Mel: And that's something you get inside as one of the benefits in the My Financial Adulting Plan is we can't cover every suburb and every area, but we've got a little black book of things like buyer's agents and mortgage brokers that we really like, so that if someone's going, ugh, I'm thinking. Australia, for example, we can go, yeah, sure, we can help with that. If they're in the UK, we can go, sure. We can help with that. So it's that it's knowing who you can talk to, which is just as important as where I should be buying, because a good buyer's agent will be able to give you property reports. They'll be able to give you suburb reports. They'll be able to show you with research. So if you go and think you're going to a buyer's agent and all they're doing is peddling new apartments to you, that is not a buyer's agent. That is a property developer that's kind of partnered up with someone that is flogging you new apartments. So that for me would be a massive red flag if that is all they're peddling. I really wanna name a few of them, but I'm not going to but I am happy to answer DMs if someone sends me a DM and says, what? What about that one? Just to steer you away. So that's kind of both what it is and what it isn't. But there are some great buyer's agents you will definitely pay a fee for them.
Lawsie: well and truly.
Mel: Yeah, that fee maybe it will be dependent on the price of the property and what they do. If you buy a report that might be a much lower price than if you're going to use them to buy a property, it's usually a fee and then or a percentage of the property price.
So it might be as little as a few thousand dollars. It could be as much as tens of thousands. But what a good buyer's agent will do is they'll have access to properties before the public sees them, and they should be able to negotiate so that you will have saved what you've given them in the cost of it. Plus they're gonna stop you from making stupid decisions. So that's where it's worth it.
So, hubby and I are definitely looking at an interstate property. In the next couple of years. We will absofreakinglutely be using a buyer's agent. Cause I just do not know those markets as well. Plus it's that extra thing of just say you're looking in Brisbane. I don't know the flooding regions. I don't know those areas where the homes could be problematic. A good buyer's agent will know that.
So it's having that, and as I said, inside the My Financial Adulting Plan, that's one of the perks is that weāll put you in touch with them.
But essentially diversification helps to lower your overall risk. With property it might you might be heavy in a suburb or you might be heavy in residential so you look at adding commercial. You might be heavy in apartments, so you're looking at adding house and land.
It's just being smart and having that diversification across geography and even the type of property. But essentially the thing I take away, I want you to hear is diversification helps to lower that risk that we talked about in the beginning, and that's because as we've talked about today, different asset classes tend to do well at different times.
So, if the share market, if the property prices are falling, usually it's not necessarily happening at the moment, but usually the share market is starting to increase. If they're both going a little bit haywire, you've got the bonds market that's usually quite steady. So the idea is that they all equal each other out, and that's why bonds are considered hedged.
That's a way to hedge your investments because it's kind of keeping it a little bit safe while the others are bouncing around potentially a little bit. But as we said, it's choosing not to have all your eggs in one basket.
Now your job is to think about how you are currently investing. So what I want you to do now is to take the time to think about how you are currently investing, where your eggs are being stashed. Are you property heavy? Are you property in a particular suburb heavy? Are you share heavy? Are you shares in a particular industry heavy? Are you cash-heavy?
I'm definitely seeing people hoarding cash and not being really reluctant to start. So are you cash-heavy? And what's one thing you can do to start to move or spread your eggs around? So Lawsie I thought you and I might talk about a few ideas now. So if you're property heavy, you might decide to start investing in shares.
And if you are thinking, ugh, I don't have spare cash, you might look at downloading something like Shop Back or Cash Rewards, putting it on your browser and using that reward cash to invest in shares. You could use roundup or you might just use a hundred bucks a month, which a hundred bucks a month invested over 20 years at seven to 9% is over a hundred grand. So this is something where even small amounts make a huge difference. So that's one thing you can do if you are property heavy.
What if you were share or as sector heavy Lawsie?
Lawsie: Yeah, I think if you are particularly heavy in one share or sector, then it is one, realizing that and figuring out which sector and stuff you're in, and then working out a plan to give yourself exposure to other companies and other sectors and even other countries like, like even if we were to look at exchange traded funds again, for example, you might only have, say, Australian shares and you go, oh, but hang on, I'm therefore missing out on things that could be happening in the US market or Europe, China or whatever it is. So it's just being aware of like, okay, yes, I've got diversification with Australian shares, but is my next step that I wanna start getting diversification or exposure to other markets? Or other types of assets as well. Cause you might go, I don't have bonds, or I don't have gold. And they're generally considered a little bit more safe assets, so you might wanna start to make a plan to go, all right, yes, this is where I'm going to still put most of my funds or say, but I might also start, starting to increase my exposure to those assets.
Mel: Yeah. And we're not suggesting that you necessarily want to sell anything that's not. We don't want you to hear that. But what we're saying is how can you start to rebalance that? How can you start to add to it so that it's not like that. And if you wanna create that beautiful plan, if you wanna actually sit there and go, right, what is my long-term plan? What do I want these to be? Make sure you jump on the wait list for the My Financial Adulting Plan, cause that's something we teach you in there. We teach you how to create your own financial plan. We teach you to ask how to answer questions like how much is enough so that you can create that portfolio to suit.
If you were property heavy or you had one share and you were still a bit, ugh, I don't know, make sure you check out the shares and the property masterclass as well, cause they'll give you some tips and tricks for what you can do and we'll put those links in below. But what we want you to have heard today is it is a risk. It's like getting in the back of a white van like I stupidly did, or Lawsie pedalling after a niece going down a stupidly happy hill going stop.
Lawsie: It's never gonna end well.
Mel: to be investing in the one thing or the one industry, it's absolutely not something that we wanna do. Think about how you are over-invested somewhere.
Think about how you might wanna rebalance that or change that mix. And then what's the first thing you're gonna do to start?
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