Increased chance of returns and reduced risk are just two reasons for a varied portfolio
How much is too much? It’s a good question when looking at the best ways to make diverse investments work. Of course, investors stocking up on “too much” of one lucrative option could be in for serious losses if that asset class hits a rough patch. But diversification without accepting its potential downside can also detrimental. Reaping the benefits of a balanced portfolio requires investors to understand both their own nature and that of the market.
Diversification educates investors about risk
The amount of tolerable risk in a portfolio is ultimately down to the individual. One investor’s limit will be too low for another. The degree of diversification a person is open to helps them better assess how much they’re willing to lose in a downturn.
Broad diversification sidesteps the risks of having only a handful of investment types, but it also adds more potential risk for every new addition and the risk of losing out on better returns for currently well-performing holdings. The investor with 30 options needn’t be overly concerned about one having a rough patch but must accept a wider (if shallower) pool of risk.
It’s a widely held belief that the best portfolios bring investors as close to their long-term financial goals as possible while respecting individual risk tolerance. This is the core of Markowitz’s Modern Portfolio Theory—a Nobel Prize-winning work.
Diversification does allow for both aggressive and conservative investment
Certain investments may become more (or less) attractive as investors learn more about diversification. Fixed annuities and certain stock indices are generally seen as more conservative portfolio choices, while options like certain real estate vehicles or venture capital are considered aggressive due to higher associated risk.
Diversification gives investors an opportunity to weigh the pros and cons of conservative versus aggressive options. Those inclined toward lower-risk investments may find themselves open to stepping out of comfort zones, provided their portfolio is diverse enough to absorb any potential loss from riskier additions.
The more aggressive investor benefits in the same way by being better able to continue making riskier decisions, provided they have some of the more traditionally secure portfolio options in place to buffer negative outcomes.
Diversifying preserves as well as produces capital
A broader portfolio is often an especially sound idea for investors approaching, or enjoying, retirement. It helps them to better preserve their capital and provides a level of security that can’t be guaranteed when pursuing higher rates of returns.
Highly diversified portfolios are rarely stratospheric in terms of performance. Rather, their overall performance is an amalgamation of many markets and vehicles, leading them to rarely over or underperform. This can be a great virtue, depending on your inclination. While diversified returns may not often make the headlines, a diverse portfolio can provide a level of consistency that is more than reward enough for many investors.
Diversifying across unrelated classes can significantly increase investment safety
Combining unrelated asset classes is another cornerstone of Modern Portfolio Theory and can be of great benefit. Asset classes that are separate and distinct from one another are collectively immune to the individual dangers of each option. In some cases, non-correlated choices may even eliminate unsystematic risk altogether.
This, of course, does not remove systematic risk, which is inherent in any asset class. However, a non- correlated portfolio can provide a valuable overall balance to investor returns. Investors seeking to take this route must diligently research investments to determine to what degree their individual choices may share potential highs and lows.
Correlation is not always immediately evident. It may take some digging to discover how the fortunes of one asset class may affect another, making working with experienced wealth advisors a smart option.
More options mean greater market immunity and personal freedom
Long-term investment is like captaining a ship to its destination. Sometimes, course corrections will be necessary and so will proceeding, retreating, or holding your ground. Diversity allows for better rebalancing of portfolios and adjustment of investment goals to compensate for market shifts and goal reorientation.
Risk tolerance will not only vary from person to person but can also vary over time within individuals. Markets are forever in flux and the personal goals of investors can be equally organic. What was too much risk yesterday may be quite acceptable tomorrow, and vice versa. Keeping a diverse portfolio allows for flexibility in adjusting targets.
It must also be clearly understood that despite its benefits, diversification is of course no guarantee of a positive return. Indeed, no mix of asset classes or investment model can provide that assurance for any investor. In theory and historical practice, however, diversifying a portfolio sets it in the best possible position to accrue more stable and consistent returns over the long-term.
Lindberg & Ripple offer diverse opinions for your individual goals
Exploring the potential for returns and security through diversification is necessary for investors and best done alongside a seasoned investment advisor. The Lindberg & Ripple team brings its own rich diversity and insight to wealth planning, blending our individual specializations into a coordinated approach to help our clients achieve their goals.
Lindberg & Ripple offer customized wealth management, investment and insurance solutions to wealthy families and successful businesses. We help our clients craft a comprehensive wealth planning model to achieve their financial goals with minimum fuss and maximum savings. To learn more connect with us at our Connecticut or Florida offices or complete our contact form.