Making the most of hard earned capital
When we think about investing, we spend a lot of our time and energy making sure our investments perform well. Whether it’s strong capital growth or a constant stream of dividends (or ideally, both!), we devote a lot of time to ensuring our money is out there working hard for us. But what are we doing to protect that money once we’ve got it?
Thinking about protecting our nest egg is, admittedly, not as exciting as thinking about how to grow it. It’s thrilling and addictive looking for the next big thing, the next small cap company that might be your winning lottery ticket. We all want to find the next Apple or Amazon stock, buy it when it’s cheap and watch our money grow before our eyes.
Ensuring there’s a safety net
But when it comes to investing our hard-earned dollars, having a good defence is just as, if not more important, as having a strong offence. Why? Because growth stocks are notoriously volatile and unpredictable. It’s a great ride when they’re on the way up, but when they fall, it can really hurt – especially if you don’t have a safety net in place.
Consider this. Let’s say you’ve spent a few years building up an investment portfolio. You’re looking for capital growth so you’ve decided to be aggressive in your strategy and exclusively invest in shares. You’ve made sure you have a nice mix of Australian shares as well as international shares from the US and emerging markets.
You’ve enjoyed great growth over the past few years and your portfolio is all in the green. Then, there’s a correction in the stock market and pretty much every one of your shares falls in value. Suddenly, it’s not so green.
Creating a defence through diversification
Now let’s take a look at another scenario. In this example, you’ve again spent a few years building up your portfolio. But instead of just being all on the offence, you’ve put some thought into a strong defence too. Your portfolio is a nice mix of Australian and international shares. In addition to that, you’ve also got some bonds and maybe a term deposit or a high interest savings account in the mix too.
You’ve still enjoyed a good level of growth over the past few years, except this time when there’s a correction in the stock market, it hurts a lot less. While your shares have mostly fallen in value, your bonds, term deposits and savings accounts have remained stable, which helps to cushion your fall.
Sure, setting up a good defence might not be as thrilling as searching for the next Apple or Amazon stock. But, there’s certainly nothing more thrilling than making it through a fall in the market with your portfolio still relatively intact.