Facts and Fiction about Portfolio Diversification

Let’s examine the facts and fiction about portfolio diversification.

Fiction: A 60/40 stock and bond portfolio (Nasdaq:VBMVX) is fully diversified.

Fact: Only investment portfolios with market exposure to all the major asset classes –  not just stocks and bonds (NYSEARCA:BND) – but  real estate, commodities, and cash too are fully diversified. That means a 60/40 stock and bond investment mix is a really good start toward diversifying, but still incomplete.

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Fiction: Portfolio diversification is a hedge for ignorance.

Fact: Anybody with the misinformed view that diversification is for losers needs to familiarize themselves with Yale University’s endowment.

Yale’s endowment returned 11% per annum over the 10 years ending June 30, 2014, surpassing broad market results for domestic stocks, which returned 8.4% annually, and for domestic bonds, which returned 4.9% annually.  Even more impressive is how Yale’s endowment generated returns of 13.9% over the past two decades compared to the estimated 9.2% average return of college and university endowments. How did Yale do it? By diversifying investment risk – not concentrating it – across a variety of different assets like commodities (NYSEARCA:DBC), real estate (NYSEARCA:VNQI), and private equity (NYSEARCA:PSP).

Fiction: Diversification prevents losses.

Fact: The purpose of diversification is to spread investment risk across a variety of different asset classes in order to reduce risk. While this should help to cushion your investments against the impact of a market crash, it won’t completely eliminate the possibility of market losses.

Fiction: Securities diversification is all that matters.

Fact: A well-rounded investment plan incorporates more than just securities diversification, but also currency diversification and making sure your assets are diversified across various financial institutions.

Does your portfolio pass or fail on diversification? Get your personalized Portfolio Report Card and find out.

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