FIS Evidenced-Based Investment Insights: The Full-Meal Deal of Diversification
October 24, 2014 | By fischer |
Welcome to the next installment in our series of FIS Evidence-Based Investment Insights: The Full-Meal Deal of Diversification
In our last piece, Financial Gurus and Other Unicorns, we concluded our exploration of the formidable odds you face if you (or your hired help) try to outsmart the market’s lightning-fast price-setting efficiencies. Today, we turn our attention to the many ways you can harness these and other efficiencies to work for, rather than against you.
Among your most important financial friends is diversification. After all, what other single action can you take to simultaneously dampen your exposure to a number of investment risks while potentially improving your overall expected returns? While they may seem almost magical, the benefits of diversification have been well-documented and widely explained by some 60 years of academic inquiry. Its powers are both evidence-based and robust.
Global Diversification: Quantity AND Quality
What is diversification? In a general sense, it’s about spreading your risks around. In investing, that means that it’s more than just ensuring you have many holdings, it’s also about having many different kinds of holdings. If we compare this to the adage about not putting all your eggs in one basket, an apt comparison would be to ensure that your multiple baskets contain not only eggs but also a bounty of fruits, vegetables, grains, meats and cheese.
While this may make intuitive sense, many investors come to us believing they are well-diversified when they are not. They may own a large number of stocks or stock funds across numerous accounts. But upon closer analysis, we find that the bulk of their holdings are concentrated in large-company U.S. stocks.
In future installments of our series, we’ll explore what we mean by different kinds of investments. But for now, think of a concentrated portfolio as the undiversified equivalent of many baskets