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Investment and inflation risk
As discussed earlier, one of the primary reasons for portfolio investing or diversification is to maximise your return while minimising risk.
There are several types of risk which are minimised by the practice of portfolio investing or diversification.
Maximising return and minimising risk is best demonstrated by the concept of investment risk, when you miss out on the high returns of one asset class, because all your investments are in another asset class which is performing less well. At any given time, one of the investment classes - shares, property or bonds and cash - will show superior returns against the others. Therefore, to minimise investment risk, ensure your portfolio includes all three classes.
It's important to note, though, that while you can spend hours trying to determine which is the right share or property to invest in, research consistently shows that it's the asset class in which the investment is made that matters, rather than the specific investment option.
You need to include growth assets, such as shares, in your portfolio. This will protect you from inflation risk. While inflation is minimal today compared with previous decades, any level of inflation (even at the relatively low levels we're currently experiencing) will have some impact on your long-term return. Who's to know what the inflation dragon will look like in five to ten year's time?
Putting all your savings into New Zealand investments is a risky strategy, even over the long term. The next page looks at economic and currency risks.