Another reason to spread your investments
I can think of three good reasons to hold lots of different shares, as opposed to one or just a few. Two reasons are obvious, but one is less so, even though it may be just as important.
Let’s start with the obvious:
- You’re much less likely to lose all or lots of your money. Most companies don’t go bust, but with just a few shares you could strike bad luck.
- When the prices of some shares fall, others will almost always be rising, so your total portfolio has a much smoother ride. This is easier to cope with psychologically.
The less-obvious reason: the lower volatility lets you get more mileage out of compounding returns.
A recent ABN Amro Craigs newsletter gives an example of two portfolios:
- Well-diversified Portfolio A , which has the following percentage returns over ten years: 5, 6, 5, 4, 5, 6, 5, 4, 5, 5.
- Undiversified Portfolio B, which has the following returns: 15, 30, minus 15, 30, minus 40, 20, minus 30, 30, 20, minus 10.
The average return for both portfolios is 5 per cent. But if you put $10,000 in A, after ten years you would have $16,286. In B you would have only $11,690.
Admittedly, the huge difference is the result of an extreme example. A’s returns are smoother than you could ever expect with shares, and B’s returns would give you an incredibly rough ride. With more realistic examples, the difference would be considerably less.
Still, the point is a valid one.
Why does it happen? Mainly because losses muck things up. If you lose a certain percentage one year, you need a bigger percentage gain to get back to where you started.
For example, a 30 per cent loss on $10,000 leaves you with $7,000. You then need to gain almost 43 per cent to return to $10,000.
As ABN Amro Craigs puts it, “1. Don’t lose money. 2. Don’t forget rule 1.”
While you’ve got to expect annual losses every now and then on a portfolio of any size, the more diversified you are, the fewer losses you will suffer.
NOT SO SUPER?
I really fell into it when I wrote in my last column, “Every New Zealander over 65 gets NZ Super, no matter how rich they are.” What I meant was: there is no income or asset cutoff for NZ Super.
However, several readers, some of them quite angry, wrote to say they are ineligible because they receive superannuation from the government of another country where they used to live.
This is an issue that has been battled over for years.
Some say: Why shouldn’t they receive both pensions? Others, who have contributed to, say, a work super scheme can receive that as well as NZ Super.
Others say: Why should someone who has lived in, say, the UK or US as well as New Zealand end up receiving more from the two governments than a lifelong Kiwi gets from one government?
I could argue either way. But I’ve been there before, and nothing was resolved. Thanks for your letters, readers, but this is not the forum for them.
Another reader wrote, “It is appalling and disgraceful that you refer to NZ Super as a government handout. It is in fact part of a social contract to which most citizens, as taxpayers, contribute throughout their lives…. Shame on you.”
I could challenge what you say about contributions. That’s not quite how it works — a point around which the battle above rages. But again, let’s not. There are better uses for this column.
Sorry if the word “handout” offended you.
Mary Holm is a freelance journalist, a director of Financial Services Complaints Ltd (FSCL), a seminar presenter and a bestselling author on personal finance. From 2011 to 2019 she was a founding director of the Financial Markets Authority. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary’s advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it.