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Diversify not just over shares, but also over years

By Mary Holm

Monday 4th February 2002

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Investing in a share fund, but for just one year, is rather like investing in just one share.

I've written often that it's better to spread your share investments over many different shares, perhaps via a diversified share fund. You reduce risk without reducing average returns.

I've also said many times that any share investment should be for at least several years.

But I haven't pointed out that both of these "rules" are about diversification.

You should diversify over lots of different shares and lots of different years, so the good can offset the bad.

There is, though, a down side to diversification. While you avoid disaster, you also miss really high returns.

Investors in share funds sometimes look wistfully at those who put lots into a single share whose value soared.

The same applies to diversification over time.

A Newsweek article gives some interesting data on your chance of making more than 20 per cent a year on a diversified share investment.

If you invest for just one year, you have a 37 per cent chance of making such a high return. That's more than one in three years.

If you invest for three years, it drops to 19 per cent. On a five-year investment, it's 10 per cent; over ten years, it's just 1 per cent; and over 20 years, forget it.

The longer the investment, the less likely that you'll do extremely well.

On the other hand, the longer the investment, the less likely that you'll do extremely badly.

Newsweek also looked at your chance of losing money.

Over a single year, there's a 26 per cent chance you'll end up with less than you started with.

Over three years, that drops to 14 per cent. (Still, everyone currently smarting from two bad years in international share funds should realise there's a one in seven chance that this year will also be a loser.)

On a five-year investment, you'll lose 10 per cent of the time. Over ten years, it drops to 4 per cent; and over 20 years it's nil.

Not only that. At 20 years, you've got a 63 per cent chance of getting an annual return of more than 10 per cent. That's a bigger chance than for any shorter period.

We should note that this is all historic data.

With lower inflation around the world, and Baby Boomers retiring and therefore spending more and saving less, experts predict that average returns on all investments will be lower in future. On shares, they expect returns in the high single digits.

Still, the message seems clear. Unless you're a gambler, your share investments should be long-term. (Hang in there, international share fund investors!)

Diversification over time also applies to buying and selling share investments.

Because share prices are volatile, there's always the danger that if you put a lump sum into shares or a share fund, you'll buy at a time that turns out to be a market peak.

Or if you sell a large quantity, you might get out at what turns out to be a trough.

You can reduce your risk by spending, say, a quarter of your lump sum now, and the rest in equal amounts perhaps 6, 12 and 18 months from now. In the meantime, put the money in term deposits that mature at the right times.

If you're getting out of a share investment, try to similarly spread your withdrawals over a year or two or three.

It's important to set a timetable and then stick to it, whatever is happening in the market. More people lose than win by trying to time their investments or withdrawals.


Mary Holm is a freelance journalist and author of "Investing Made Simple", commissioned by the New Zealand Stock Exchange to write an independent personal investment column. She can be reached at maryh@pl.net. Sorry, but she cannot respond directly to readers.

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