We all want to make our money work as hard as we do. That is why we invest. Any successful investment strategy will involve balancing risk and reward. The aim is to mitigate risk, insulating portfolio against adverse external changes, while still retaining the potential for high returns. That is why diversification is key.
The below chart shows annual returns for eight broad-based asset classes, cash, and a diversified portfolio ranked from best to worst from 1994 to 2013.
Economist Harry Max Markowitz first introduced the risk-management technique of portfolio diversification in the early 1950s. A Markowitz-efficient portfolio assumes that through asset allocation investors can achieve maximum expected returns for the individual’s risk-tolerance. Conversely, the theory also assumes investors can minimize risk for an expected return.
Here are a few fundamentals of diversification:
· Spread the wealth: spreading your assets among investment types, styles and markets reduces the risk of one cataclysmic market event wiping out all your investments.
· Take your time: If you can keep investing at regular intervals, you have much more flexibility and can smooth out the peaks and troughs created by background market volatility.
· Think global: The premise behind geographical diversification is that markets in different parts of the world are less correlated to one another, so if you want to invest in another country ensure your portfolio has a mix of both stable, developed countries and emerging nations. Even similar assets in different geographical locations can have a low correlation.
· Maintain a comfortable mix: A thinly spread portfolio is difficult to manage to the level that is required to stay ahead of the market. Variety is key, not quantity.
· Resist the urge: when tempted by current market conditions, investors should stay true to a long-term financial plan. The stock market buzz never stops.
Your money is too important to invest without a plan. No investment strategy, including diversification and asset allocation, guarantees a profit or protects against a loss. Speak to Dino Zavagno or a member of his team at Gladstone Morgan to understand diversification and explore investment strategies that can help you achieve your financial goals. info@gladstonemorgan.com
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