How diversified is your portfolio?

A recent survey by Investment Trends found that the average self-directed investor in Australia holds shares in just 18 companies with a large portion to a few stocks, namely the big four banks, Telstra and BHP since they represent almost 50% of the market.

Having such a large part of your portfolio exposed to just a few stocks means you're taking a lot more risk than you need to be.

Vanguard estimates that the average self-directed portfolio contains about double the risk of a typical diversified growth fund, largely due to this high exposure to just a few Australian companies.

If you manage your own savings it's crucial to appreciate the links and relationships between different investments in your portfolio.

These correlations could cause much larger fluctuations during periods of market turmoil and can be avoided (without sacrificing returns) through greater diversification across different assets and countries.

For instance, Australian and global sharemarkets all fell around 5% in January. An allocation to defensive assets during that month would have significantly reduced the impact of sharemarket losses.

The defensive assets bonds and gold both had positive performance in January, helping to cushion against weak shares and smooth returns.

When you invest, you can never eliminate market risk entirely. However you can avoid having large amounts of your capital tied up in a single company, asset, industry or country.

Diversifying your savings across multiple assets, industries and geographies will help smooth your overall returns and preserve your wealth over the long run.

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