In 1952 Harry Markowitz, Nobel Prize winning economist, described diversification as the only ‘free lunch’ when seeking investment returns but is this message still relevant in 2014? By diversification, we mean investing broadly across many different types of shares and assets rather than concentrating on just one or a few. Being overweight in one share or asset can expose your portfolio to unnecessary risks. Put simply, diversification protects your portfolio against volatility by reducing the impact of any one holding’s performance on your overall wealth. We have seen the benefits of this approach recently in Paradigm Norton’s portfolios as bonds rallied strongly in October while equities had a flash crash before recovering. That said it is important to remember that diversification does not eliminate the risk of market loss. That would be greedy!
What makes diversification unique in this industry is that it is beneficial and has no extra cost. Yes there is a reduced chance of earning spectacularly high returns when holding thousands of stocks compared to a few but there is also a reduced chance of incurring spectacular losses. The costs of holding a diversified portfolio are no greater than an undiversified one and can often be much less with access to Paradigm Norton’s selected funds. The problem is you just never know which markets will outperform from year to year so by holding a globally diversified portfolio, you are best positioned to capture returns wherever they occur. As an example, ‘emerging markets’ have been both at the top and bottom of the class in recent years.
Taking this approach will hopefully smooth out the ‘bumps in the road’ during your investment timeframe. A portfolio with Paradigm Norton is likely to hold some bonds to balance the equity risk and also some international equities, smaller companies, ‘value’ stocks and emerging market stocks, amounting to over 10,000 shareholdings rather than say just 100 companies in the FTSE. Discipline, diversification and an understanding that markets are unpredictable can make your investment journey more bearable during periods of market volatility like we have experienced recently. By diversifying your portfolio you can still at least benefit from a ‘free lunch’ as you seek investment returns in an ever-changing and unpredictable world. This concept still remains very relevant today and will continue to do so in the future.
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