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Diversification: Spreading Risk Around

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Pop quiz! What single action can both dampen your exposure to a variety of investment risks and strengthen your ability to achieve your personal financial goals? Diversification.

While the combination may seem almost magical, the benefits of diversification have been well-documented and widely explained by 70+ years of academic inquiry. Its powers have been enduring and robust.

What is diversification?

In a general sense, it’s about spreading your risks around. In investing, that means it’s more than just ensuring you have many holdings. It’s also about having many different kinds of holdings. That is, you want to ensure that your multiple baskets contain not only many eggs, but also a bounty of fruits, vegetables, grains, meats, and cheese.

While this may make intuitive sense, many investors believe they are well-diversified when they are not. They may own a large number of stocks or stock funds across numerous accounts at a variety of financial institutions. But upon closer analysis, most of their holdings are concentrated in large-company U.S. stocks or similarly narrow market exposure. Owning multiple accounts that hold similar investments may feel like diversification, but it isn’t.

Think of a concentrated portfolio as the undiversified equivalent of many basketfuls of plain, white eggs. Over-exposure to what should be just one financial ingredient among many is not only unappetizing, it can be detrimental to your financial health. Poor diversification:

  1. Increases your vulnerability to avoidable risks
  2. Increases the odds for a bumpier, less reliable investment experience
  3. Makes you more susceptible to second-guessing your investment decisions

Combined, these three strikes tend to generate unnecessary costs, increased investment mistakes, and, perhaps most important of all, higher anxiety. You’re back to trying to beat formidable market forces instead of turning them into investment alliances.

There is a wide world of low-cost investment opportunities offering efficient exposure to global capital markets. Why not make best use of them? To best capture the benefits of diversification, turn to funds that focus their energies—and yours—on efficiently capturing diversified dimensions of global returns. Not sure how to evaluate your portfolio’s diversification attributes? We are here to help.

 

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