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The Building Blocks of Sound Investing - Part 3

The Building Blocks of Sound Investing - Part 3

| March 21, 2024

This week we are going to focus on diversification - the partner in crime to asset allocation. 

Diversification is a fundamental concept in investing that involves spreading investment capital across a variety of assets to manage risk and optimize returns. It's akin to the age-old adage of not putting all your eggs in one basket, and its importance cannot be overstated in the pursuit of long-term investment success.

At its core, diversification aims to reduce the impact of volatility and uncertainty by investing in different asset classes, industries, geographical regions, and securities. By doing so, you can mitigate the risk of significant losses that may arise from adverse events affecting any single investment. Diversification acts as a hedge against idiosyncratic risk, which is the risk inherent to individual assets, and can help to smooth out portfolio performance over time.

Implementing diversification involves several key steps. First, you need to identify and assess various asset classes available for investment, like equities, fixed income, real estate, commodities, and cash equivalents - that’s asset allocation. Next ,you allocate capital across these asset classes based on your investment goals, risk tolerance, and time horizon - that’s diversification. A well-diversified portfolio typically includes a mix of assets with low correlation, meaning they don't move in tandem with each other, which can provide more stability during market fluctuations.

Furthermore, diversification extends beyond asset classes to encompass geographic diversification, industry diversification, and even diversification within asset classes through investments in different sectors or types of securities. Regular monitoring and rebalancing of the portfolio ensure that diversification targets are maintained as market conditions and your circumstances evolve.

The importance of diversification cannot be overstated. Academic research and historical data consistently demonstrate that diversified portfolios tend to outperform concentrated ones over the long term, with lower volatility and a smoother ride through market cycles. While diversification may not eliminate all investment risk, it significantly reduces the potential for catastrophic losses and enhances the likelihood of achieving investment objectives.

Until next time…

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The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested in directly. 

All investing involves risk, including loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

Dollar-cost averaging involves continuous investment in securities regardless of fluctuation in the price levels of such securities. An investor should consider their ability to continue purchasing through fluctuating price levels. Such a plan does not assure a profit and does not protect against loss in declining markets.