Washington H. Soul Pattinson and Co. Ltd (ASX: SOL), ResMed Inc. (CHESS) (ASX: RMD), Macquarie Group Ltd (ASX: MQG) and Sydney Airport Holdings Ltd (ASX: SYD) shares could help you diversify your portfolio.
What is diversification?
When asked about diversification, a finance guru will usually respond with, "don't put all your eggs in one basket".
Indeed, holding multiple eggs in multiple baskets is the surest way to protect against losses – and maximise returns.
For example, if you hold two shares in equal weights and one of them falls 50%, you lose a quarter of your portfolio. But if you hold 20 shares and one of them drops 50%, you lose 2.5% of your portfolio.
How does diversification work?
To get technical for a moment, there are two types of risk. One of them can be diversified.
The other one affects the entire market and cannot be diversified.
The risk that can be diversified are those which are specific to a company, asset class (e.g. shares) or industry.
For example, both National Australia Bank Ltd. (ASX: NAB) and Commonwealth Bank of Australia (ASX: CBA) shares are exposed to market risk, which cannot be avoided.
However, they are very similar businesses, so the investor is also exposed to other risks specific to the banking sector. These can be diversified (i.e. reduced).
For example, if the investor owned shares of Woolworths Limited (ASX: WOW), part of his or her portfolio's downside might be reduced if something bad were to happen in the banking sector.
Aside from Aussie shares, you could have multiple baskets.
Meaning, in addition to Australian shares, you could have property, US shares, European shares, cash, bonds and alternative investments. Each of these assets could help smooth your investing returns and lower risk.
Here are five shares you could consider owning in a well diversified Australian share portfolio.
- Washington H. Soul Patts. Soul Patts is often called Australia's version of Warren Buffett's Berkshire Hathaway because it is a conglomerate with holdings in many other companies. It has grown at exceptional rates over many years.
- ResMed Inc. ResMed is listed on both the ASX and New York Stock Exchange. It is a global leader in the development of devices to treat respiratory conditions like sleep apnoea.
- Macquarie. Macquarie Group is Australia's largest investment bank, with operations around the globe. Unlike CBA and NAB, which are almost exclusively focused on household and business banking in Australia and New Zealand, Macquarie operates in many different financial markets and geographies.
- Sydney Airport. Sydney Airport is (yep, you guessed it) the name behind Australia's busiest airport. Given its defensive features, the company is a reliable dividend payer.
- Pro Medicus Limited (ASX: PME). Down the smaller end of the market, Pro Medicus is a technology company that prides itself on improving the transfer of medical images for medical professionals.
Foolish Takeaway
There is no way to avoid risk altogether. However, with careful portfolio construction, you could potentially avoid disaster. So after building a healthy cash buffer for emergencies, most investors should consider holding investments in shares and property, and build a strategic holding in bonds and alternative investments (perhaps via managed funds).
