Most investors understand the meaning of diversification. Webster’s dictionary explains it this way: “to balance (an investment portfolio) defensively by dividing funds among securities of different industries or of different classes”. At FAI we are constantly touting the virtues of a diversified portfolio and the lengths we take to ensure that our client’s portfolios are diversified. However, missing from most of these conversations is the “Why?”. Why is it important for investors to be diversified? In this installment we have developed an investment example to help explain the importance of diversification. In a future report, we will go into greater detail on what constitutes a truly diversified portfolio.
First, I will explain the virtues of true diversification. Assume that as an investor, you are propositioned with two investments where their annual return outcomes are known for the next 18 years (that would be nice, wouldn’t it?). I will call these investments Choice A and Choice B. Here are the returns that an investor would expect in Choice A (Blue Bars) and Choice B (Orange Bars) over the next 18 years.
Read our full 3rd Quarter Investment Commentary on Diversification: Why is it Important? by clicking here.