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 Investment Asset Diversification Articles -- Reducing Your Portfolio Risk
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(20990 reads)
When people speak of investment diversification, they may mean different things. Therefore, at the outset clear definitions are important. From the perspective of holding a well-diversified investment portfolio according to scientific investment principles, the objective of diversification is to minimize or eliminate ‘unsystematic risk’ or those risks that are not related to the price volatility of the overall securities markets.
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(41359 reads)
A well-diversified portfolio contains a very large number of individual stocks and/or bonds that are selected without bias toward particular economic segments. A fully diversified portfolio will approximate the market. During the last twenty-five years of the 20th century, fund portfolio assembly costs declined dramatically making fund investing a much more efficient and cost effective way to achieve diversification.
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(15442 reads)
No, the average investor is not at all well diversified. Instead of investing in broadly diversified index funds or across a large number of individual securities, many individual investors concentrate investments in a very small number of equities. This lack of diversification causes most individual investors to underperform a passive market return, while they suffer greater price volatility.
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(19781 reads)
Investors more easily understand investment costs that are directly measurable, such as fees deducted on investment statements. However, many investors ignore or are unaware of the “opportunity costs” of their sub-optimal investment behaviors. Opportunity costs are usually much more difficult to measure directly, but can be even higher than the more visible costs that they do understand.
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(10581 reads)
On average, the securities markets will not pay you for the undiversified risks of holding individual common stocks and fixed income securities. Individual investors should get out of the active management business and hold passively managed broad-based market index mutual funds and exchange-traded funds.
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(23730 reads)
Diversification is an extremely important investment strategy for every individual investor, and it is a genuinely free lunch. Increased diversification reduces portfolio risk or price volatility without a corresponding reduction in expected portfolio returns. Thus, if you fully diversify, you get something free – lower risk for the same expected return.
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(13057 reads)
Industry rules-of-thumb often state that 15 to 30 stocks are enough for a well-diversified portfolio. This can be very misleading. Price volatility at the individual stock level has increased substantially in recent years. In addition, the correlation of price movements between individual stocks has also declined. These changes mean that significantly increased numbers of stocks are required to achieve adequate diversification.
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(14411 reads)
No, holding a limited number of securities does not guarantee complete portfolio diversification. An analysis by William J. Bernstein challenges the idea that a comparatively small number of securities can provide adequate diversification when compared to an investment in a much broader index.
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(16886 reads)
Mutual funds are not created equally. Particularly with actively managed mutual funds, performance can vary significantly – even when those funds are pursuing similar strategies or “styles.” Holding multiple funds will reduce the volatility or risk of your portfolio.
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(13529 reads)
Additional mutual funds in a portfolio improve diversification slightly, when looked at year-to-year. However, if the terminal value of a portfolio after multi-year investment holding periods is considered, then very substantial reductions in risk or volatility can be achieved by holding multiple mutual funds.
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(11488 reads)
Company-level price risk has risen significantly in recent years, and price movement correlations between individual stocks have declined. This means investors must hold significantly more stocks to achieve diversification. Furthermore, volatility tends to jump well above average at the bottom of market cycles. Investors should understand these peaks in volatility and not just focus on the average volatility across market cycles.
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(11191 reads)
Diversification depends upon the expected equity premium and the correlation of price movements between individual stocks in the market. Depending on the size of the equity risk premium, non-diversified individual investors could unwittingly give up their entire expected equity premium. This is an extraordinarily unproductive risk to take.
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