We all know diversification is an important part of any investment portfolio – but what does it really mean and how best to do it? Tony Coleman, managing director of New Zealand Gold Merchants gives his perspective.
Diversification is one of the most vital elements of an investment portfolio – and it's essential to get it right.
Good diversification means a well-managed portfolio will have a portion invested in an area or areas not strongly aligned with the majority of the other investments.
What does that mean? Property and shares typically move in unison, so they are said to have a strong correlation. That's great when markets are bullish but can be disastrous when market sentiment turns bearish.
To protect your investments, it is important to understand why diversification is required and how to achieve it without losing out in times of low risk.
The five main investment categories are:
Investments that typically have a low correlation to shares and property are precious metals such as gold and silver and possibly Bitcoin. Investing in these helps flatten unforeseen downturns in the other investments and helps with quick cash realisation in the event you want to, say, buy more shares on a dip.
So let's look at one of the most recent examples of how this protective diversification works: The advent of Covid-19 in February-March last year was an enormous shock to markets globally – and they tumbled. The Dow Jones Industrial Average fell 35 per cent in March 2020 before enormous financial stimulus (trillions of dollars) propelled the markets to new highs.
While the Dow fell 35 per cent, gold fell only by 12 per cent – before it too was propelled to new highs. Bitcoin fell over 50 per cent before recovering; it then levelled off before going supersonic. Unfortunately, since topping out in April, it is down by 50 per cent-plus.
BITCOIN PERFORMANCE SINCE INCEPTION
The ability of gold to absorb initial market shocks and accelerate higher is a major reason it is used to diversify a balanced investment portfolio.
There are other reasons of course:
•Gold is old school, it's analogue in a digital age
•There is not password to remember
•It can't be hacked
•It's an excellent store of value
•It is really easy to buy and sell, payment is immediate.
•It can be stored in a secure facility – but has global currency. If, for example, you needed funds to get to children overseas or to cope with some emergency, you can easily sell some and have the funds moved anywhere in the world.
I look at how much debt is being created by central banks and I just know it's not sustainable, something's got to give.
Central banks are printing eye-watering amounts of money (so-called quantitative easing) and you have to ask the question: how does this not devalue the currency or become inflationary?
I think it is inflationary; quantitative easing has pushed up asset values and will inflate consumer prices. Higher demand for products and services and low supply equals higher prices.
So what will happen to interest rates? In another age they would have increased to tighten money supply. Now? Who knows? Economics has been turned upside down.
All I see is risk, the traditional investment markets are in a bubble to end all bubbles – so I'm looking for the anti-bubbles and I believe gold is one.
Banks now offer a rate of interest far below nominal inflation, so you are guaranteed to lose money (buying power) on term investments.
That seems wrong considering, when you deposit funds into your bank, you are now just an unsecured creditor. Too bad (for you) if the bank runs into trouble – and it has been known.
Gold may be analogue, but it has protected wealth for centuries – and will continue to do so into the future.