Diversification
What Does Diversification Really Mean?
Diversification smooths out the pattern of returns in your investment portfolio. If properly diversified your investment returns should look (and feel) less like a bungee jump and more like an escalator ride. Diversifying allows you to minimize the affects from the poor performance of one investment by spreading the risk out over many investments. Spreading your portfolio over 10 or more investments provides over 90% of the benefits of diversification.
However, narrow use of diversification leads to poor returns for many investors. Too many investors feel proper diversification is achieved by spreading a portfolio over 10 stocks. The gains from diversification using this narrow focus is the avoidance of risk associated with one of the stocks, but all that is gained is the difference in the risk between those 10 stocks. The more closely related the stocks the less gain there is from diversification. For example if you owned 10 homebuilding stocks you gain over 90% of the benefits of diversification from the poor performance of one of the stocks. However, you would still be fully exposed to homebuilding and gain no benefits from diversification if homebuilding performed poorly.
To achieve the maximum benefits from diversification investors need to diversify at two levels. The first level is at the security level. This level is where you want to own 10 or more stocks in a particular asset class. An asset class is a catagory distinguishing one type of investment from another. For example, CDs, bonds, stocks, oil and real estate represent different asset classes because they are different in terms of risk, reward and income. The second is at the asset class level. This level is where you want to own 10 or more asset classes. Most investors narrowly focus on the first level of diversification without considering the exposure to risk they could eliminate if they considered the second level.
Asset class allocation determines how an investor's portfolio gets divided up between different asset classes. Diversifying asset classes allows investors to gain the maximum benefits of diversification due to asset classes different risk, return and income characteristics. Determining the best asset class allocation has by far the largest impact on the returns of an investors portfolio. Noble prize winning research has shown the over 90% of investment portfolio performance is dictated by asset allocation decisions.
*Brinson, Singer & BeeBower "Determinants of Portfolio performance: An Update," Financial Analysts Journal, June '91
Once the asset class allocation is determined then investors need to diversify each asset class at the security level. This broad use of diversification provides the benifit of minimizing the risk associated with each security in each asset class and the risk of each asset class in the portfolio. The pupose of IMYERS Diversified Asset Class Allocations, DACA, is to achive this level of diversification. Doing this allows investors to achieve their return goals with the least amount of risk.
For more information about asset class alloction please click here.
For more details please contact us at 206-251-2721 or info@investingmyers.com
Diversification smooths out the pattern of returns in your investment portfolio. If properly diversified your investment returns should look (and feel) less like a bungee jump and more like an escalator ride. Diversifying allows you to minimize the affects from the poor performance of one investment by spreading the risk out over many investments. Spreading your portfolio over 10 or more investments provides over 90% of the benefits of diversification.
However, narrow use of diversification leads to poor returns for many investors. Too many investors feel proper diversification is achieved by spreading a portfolio over 10 stocks. The gains from diversification using this narrow focus is the avoidance of risk associated with one of the stocks, but all that is gained is the difference in the risk between those 10 stocks. The more closely related the stocks the less gain there is from diversification. For example if you owned 10 homebuilding stocks you gain over 90% of the benefits of diversification from the poor performance of one of the stocks. However, you would still be fully exposed to homebuilding and gain no benefits from diversification if homebuilding performed poorly.
To achieve the maximum benefits from diversification investors need to diversify at two levels. The first level is at the security level. This level is where you want to own 10 or more stocks in a particular asset class. An asset class is a catagory distinguishing one type of investment from another. For example, CDs, bonds, stocks, oil and real estate represent different asset classes because they are different in terms of risk, reward and income. The second is at the asset class level. This level is where you want to own 10 or more asset classes. Most investors narrowly focus on the first level of diversification without considering the exposure to risk they could eliminate if they considered the second level.
Asset class allocation determines how an investor's portfolio gets divided up between different asset classes. Diversifying asset classes allows investors to gain the maximum benefits of diversification due to asset classes different risk, return and income characteristics. Determining the best asset class allocation has by far the largest impact on the returns of an investors portfolio. Noble prize winning research has shown the over 90% of investment portfolio performance is dictated by asset allocation decisions.
*Brinson, Singer & BeeBower "Determinants of Portfolio performance: An Update," Financial Analysts Journal, June '91
Once the asset class allocation is determined then investors need to diversify each asset class at the security level. This broad use of diversification provides the benifit of minimizing the risk associated with each security in each asset class and the risk of each asset class in the portfolio. The pupose of IMYERS Diversified Asset Class Allocations, DACA, is to achive this level of diversification. Doing this allows investors to achieve their return goals with the least amount of risk.
For more information about asset class alloction please click here.
For more details please contact us at 206-251-2721 or info@investingmyers.com