What Is Diversification?
By TROY SEGAL Reviewed By GORDON SCOTT
Updated Mar 6, 2020
Diversification is a risk management strategy that mixes a wide variety of investments within a portfolio. A diversified portfolio contains a mix of distinct asset types and investment vehicles in an attempt at limiting exposure to any single asset or risk. The rationale behind this technique is that a portfolio constructed of different kinds of assets will, on average, yield higher long-term returns and lower the risk of any individual holding or security.
Am I Really Diversified?
By R. JEFF GREEN
March 1, 2020
Many Investors think they are diversified, but this is far from the truth. Three common problems have become evident after reviewing individual’s investment strategies over the years:
- A primary focus on US Large and a disregard for US Small.
- A lack of International Large and Small
- Overlap in their portfolio.
Let’s take a look at why this happens.
(1) US Large Stocks or otherwise known as Big Cap Stocks are very large companies that are publicly traded. Names of these companies are very recognizable like, IBM, McDonald's, Walmart and GE. They are also called Blue Chip stocks because they have a great reputation, have been in business a long time and operate on a steady basis even during a downturn. The S&P 500 is an Assets class with 500 companies; thus, many believe that if they hold several of the Big Boys they are in good shape.
This misconception is that the Large US companies come with less risk than the small companies. History can prove otherwise such as: GM, Enron, Washington Mutual, World Com, Lehman Brothers and PG&E. Also keep in mind that US Large companies act and respond in similar ways, thus having a majority in US Large creates unnecessary risk. A diversified portfolio needs Small Cap or Small Stocks because returns are generally higher and the extra diversification creates a hedge against volatility.
(2) Most investors are heavily weighted in domestic stocks. The National Bureau of Economic Research suggest that the average investors have about 90% of their holding in US alone. We are in a global economy therefore international is a great way to diversify and see good returns. A mix of Large and Small Cap International is a must in a well-balanced portfolio.
(3) Have you ever run an Over-Lap report on your portfolio? Most have never done it and the ones that do are shocked. More often than not, we will find that an investor with a mix bag of investments are actually not diversified. They have four different mutual funds that are almost duplicate of their holdings. It looks good but lacks diversification.
Don’t just hope your portfolio is diversified. Take action to find out. It will go a long way towards better returns and a hedge against market volatility.
HARRY MARKOWITZ Winner of the Nobel Prize in Economics and Matson Money Academic Advisory Board Member
“A good portfolio is more than a long list of stocks and bonds.
It is a balanced whole.”
We systematically evaluate allocations in our portfolios and rebalance them regularly to target optimal results. This approach - based on extensive scholarship and Nobel Prize-winning investing science - eliminates the myths of stock-picking and market-timing from portfolio management.