Have you heard the saying “don’t put your eggs in one basket”?
That’s diversification. It’s when you spread your money across a bunch of different investments, so you protect yourself from the risk of one of them failing.
It’s often given out as a top tip when you’re looking for advice about investing.
But why? Let’s use eggs to illustrate this.
Introducing the Super chicken
Say you’ve got $100, and you want to get into the egg business (free range of course). Lucky for you, a chicken salesman has a Super Chicken that he’ll sell you for $100.
Super Chicken can lay 10 eggs a week, and you can sell them for $1 each. It’s a no-brainer, right? You’ll make your money back in 10 weeks, and on week 11, you’ll be making pure profit. You’ll be the egg king of your town in no time. People will come from far and wide whenever they’re hungry for an omelette.
- Super Chicken gets sick and can’t lay eggs for awhile
- The neighbour’s cat gets too close
- Super Chicken goes way too free range and starts laying her eggs all over the garden, so you can’t find them
If any of these things happen, what’s your fallback? You don’t have one, because you spent all your money on Super Chicken. Stink!
A better idea
Here’s an alternative: you buy 4 regular chickens for $25 each. Each chicken lays 2 eggs a week. Pretty solid, but hardly Super Chicken material. And you make a bit less money per week, because where Super Chicken was earning you $10 a week, these four chickens (bless them) are only making you $8 a week.
But think about the scenarios we ran through up above. If one chicken gets sick for a week, you still get $6 from the other three chickens’ eggs. If that cat comes back, you’ve still got $4 a week to play with. And if you’re having a really bad week, and the third chicken goes rogue and starts hiding eggs, you’ve still got $2 left over.
It’s not the $8 you expected, but it’s more than $0—and three bad things have happened! With Super Chicken, if just one bad thing had happened, you would have lost your entire income.
What’s the catch?
That was a lot of numbers just then, so you may have missed that Super Chicken was giving you $10 a week while the regular chickens were only giving you $8 a week. That’s the price you pay for diversification. When you diversify, you sacrifice some of the profits in order to protect yourself from the losses.
Umm… Sharesies doesn’t actually have anything to do with chickens or eggs
We know, we know.
The same concept applies to shares. You can invest in individual companies, but it’s not exactly unheard of for companies to go under. If this happens and you have all your money in one company, that’s it for all your money.
That’s what’s great about the funds available through Sharesies. Each one for example, the NZ Top 50 Fund—gets you a piece of a bunch of companies. So if you have some shares in the NZ Top 50 fund, if one of those companies has a bad year, or goes out of business, you still have a little piece of 49 other companies to pick up the slack.
We think that’s pretty cool.
Ok, now for the legal bit.
Investing involves risk, including the potential loss of principal. The info provided above isn’t a recommendation to buy, sell or hold any financial products available through the Sharesies platform. Before investing, consider your investment objectives and read the fund’s product disclosure statement carefully. It contains the fund’s investment objectives, risks, charges and other information which should be considered carefully before investing.