A surprisingly large number seem to view diversification as something irritating – but why ?
Take one couple I heard of who inherited a lot of money. They decided to put all their money into 20 rental houses in Invercargill, as they were relatively cheap and so the rental yield was quite good.
Over the summer holidays, I was asked what I though about this. I try to avoid such discussions, but I did remark that I would worry about diversification. Talk about a conversation killer - a deadly silence followed.
Some of the risks
Let’s have a look at some the regional risks, be it shares in local companies, or rental houses.
Kaitaia – the economy all too reliant on the Juken Nissho tri-board mill.
Auckland – property prices extrememely high, more government intervention, or a small increase in mortgage rates, could create havoc.
Hamilton – dairy service town, foot-and-mouth disease could be disastrous.
Te Puke – PSA disease in Kiwifruit orchards has hurt the local economy.
Wellington – earthquake risk, and only one road in and out.
Christchurch – still sitting on various fault lines.
Invercargill – heavily reliant of the aluminium smelter, threats of closure in the wind.
Westport –cement company Holcim has announced plans to shut its cement manufacturing plant with the loss of 120 jobs.
Oamaru – hoped to, but did not get the cement plant either, as Holcim will now cease making cement in NZ.
West Coast – opportunities for developments and jobs very limited, and “green” limitations everywhere. Our political masters (should that be servants ?) in Wellington have let the people of the West Coast down badly.
Australia - some people who concentrated their assets in a single area got wiped out by bushfires.
Greymouth – mining disasters like Pike River, where investors lost 100%.
Nb. the author acknowledges with respect the lives lost, and their families, in Christchurch, Pike River, and Australia.
There are dozens and dozens of unforeseen risks
No one could ever foresee all the risks, but diversification is a simple and highly effective tool for investors to use to mitigate risk.
Nothing ventured, nothing gained
Nothing is risk free, of course, and small investors have to start somewhere.
But prudent investors don’t ignore risks
Yes, diversification is boring.
Sometimes it takes you into investments and places you don’t know well or understand well either, but prudent investors work around that – they get advice when they don’t know.
Risk and loss is all too real
These invested heavily into Christchurch got hit hard, especially if they had a lot of debt.
Investors in Canterbury forestry got hit hard by gale force winds last year.
Dairy farmers – those who are well established, with low debt and getting older, would be at a lot less risk if they sold up and diversified – applies to non diversified businesses and farms as well.
A businessman listed his company on the sharemarket, it floated at $1.80, but he waited till the shares hit $2, the value he thought they were worth. They eventually fell to 50 cents. By not diversifying when the price was quite good, he lost 75%. He could have used the old adage – “if in doubt, do half.” nb. A lot of new floats (IPO’s) sink.
A hard worker Te Puke built up a portfolio of rental houses, only to face a big setback as demand fell off sharply when PSA hit the orchards - little or no work for his tenants.
The global credit crunch hit all business, but some of those that concentrated all their money into the one business lost everything.
Diversification is your friend
It is simple, cheap or even free.
Sometimes it will save you from ruin.
Sometimes you won’t make as much money as your chosen asset, but overall and over time, those people who diversify properly will almost always be the survivors.
Supplied by Alan Clarke, financial & retirement adviser, & author. His second book is virtually complete, & he also writes regular articles for the media & on line – see www.acfs.co.nz
Alan is an independent authorised financial adviser (AFA) FSP26532 & his disclosure statement is available on request and free of charge.