So What Does Diversification Do For An Investor?

During 2008, the rule of diversification didn’t protect investors from loss as practically all classes of investments lost money. So what will diversification do for an buyer? The first thing you should know is it can’t assure you the highest possible return. In fact, it guarantees you will not earn the highest possible return.

By spreading your cash around you assure that you will have at least some of your money in lagging investments, which will lessen your portfolio’s potential return. With the same token, diversification can’t totally immunize you from loss. To do that, you would have to do the opposite of diversifying — i.e., plow all of your money into the most secure investments, such as Treasury bills or short-term bank or investment company CDs. What diversification can do for you, though, is offer you a shot at higher profits than you will get in the soundest investments while restricting your risk somewhat. You can’t eliminate that risk.

But by investing your money in a variety of secure and more volatile possessions, you can decrease the potential downside in a given yr. For example, if you’d had all of your profit a diversified portfolio of U.S. That kind of pillow is very important to several reasons. For one thing, it makes you less likely to panic in a negative year and sell off riskier investments with higher long-term return potential at what may be the worst possible time.

A less volatile collection is also less likely to take a damaging hit that may be difficult to recover from. That’s a particularly important consideration if you are dealing with 401(k)s or other pension accounts and you’re nearing retirement or already are retired and withdrawing money from such accounts. Therefore the key to getting the benefit of diversification is settling on a mix that’s right for you.

Ideally, your mix should contain assets that don’t all move in sync with each other or, to place it in trading terms, that aren’t too highly correlated with one another. It’s alright for gains in a few investments to offset losses in others in a few years. But on balance your increases should outweigh losses most years.

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And, while down years are inevitable with growth-oriented investments, whatever assets you’re buying should have an optimistic long-term come back. Diversification is not a secret that can change recurring sizeable deficits in your investments or your portfolio overall into long-term prosperity. But as big an advocate as I am of diversifying among a variety of asset classes, I also feel that the concept has been stretched out of shape over the years, in some cases even beyond reputation.

Specifically, I believe the advantages of diversifying have been oversold by some advisers who appear objective on making themselves come off like investment wizards with the capacity of creating all-upside-no-downside portfolios. But I’m cautious with these supposedly more sophisticated portfolios. THEREFORE I suggest keeping things simple. Start with an authentic sense of how much risk you can handle and then build a diversified stock portfolio of stocks, cash and bonds.

If you want to get more fancy, you can toss in a few international stock money and maybe some REITs or real estate-related mutual funds. But don’t overload. The more complicated your profile is and the greater wide-flung your holdings, the greater attention and treatment it’ll need. Finally, remember that to get the entire benefit of diversifying you must rebalance periodically to revive your portfolio to its proper proportions. Of course, you can always take the other route you suggest and just buy CDs. But unless you have a lot money that you can accumulate a huge enough nest egg despite their low yields, I’m not sure that can be done this and also not worry.