Diversification is one of your most important financial tools. This one strategy can simultaneously limit your exposure to investment risks while also potentially improving expected returns. Best of all, the benefits of diversification are well-documented and supported by over 60 years of academic research.
The Benefits of Global Diversification
Diversification simply means spreading risks around by populating your investment portfolio with a variety of holdings. It’s not just about putting your eggs in different baskets; diversification ensures you have multiple baskets full of eggs and lots of other foods.
This is common knowledge to investors, but the fact remains that many believe their portfolios are more diversified than they really are. You may hold large numbers of stocks or numerous accounts, but take a closer look at your portfolio. If the majority of your holdings are concentrated in large-company U.S. stocks, your portfolio will not enjoy the benefits of genuine diversification.
A well-diversified portfolio provides three key benefits:
- It decreases your vulnerability to specific, avoidable risks.
- It cushions you during bumpy financial times, providing a smoother overall investment experience.
- It gives you confidence and helps you avoid stressful second-guessing of your investment decisions.
Without proper diversification, investors contend with higher costs, lower expected returns and – perhaps most detrimental of all – increased anxiety. When you’re not adequately diversified, you’re back in the problematic position of trying to beat the market instead of playing along with it.
Think Globally
Remember, a whole world of investment opportunities is available. Designed to facilitate meaningful diversification, tightly managed mutual funds offer efficient, low-cost exposure to capital markets found around the globe.
The Bottom Line
Academic research demonstrates that working with brokers who attempt to beat the market is a waste of your time and money. While they may help you achieve some level of diversification, you’re likely to experience high costs and unnecessary anxiety without receiving much benefit.
We instead advise our clients to focus on efficiently capturing diversified dimensions of global returns and only work with fund managers who share the same approach.
To find out more about how to build an investment portfolio that works for you, read our eBook 9 Principles of Intelligent Investors.
