Diversification
Successful investing means not only capturing risks that generate expected return but reducing risks that do not. Avoidable risks include holding too few securities, betting on countries or industries, following market predictions, and speculating on "information" from rating services. To all these, diversification maybe the antidote. It washes away the random fortunes of individual shares and positions your portfolio to capture the returns of broad economic forces.
For many UK investors, the FTSE All-Share Index represents the first equity asset class in a diversified portfolio. Although this index is diversified in UK companies, investors can benefit by adding further components. Take, for example, a portfolio that holds just UK shares, a portfolio that holds international shares (ex UK), and a portfolio that holds half of its assets in each region. The diversified portfolio has a lower standard deviation and fewer negative quarters.
This is the power of diversification: the whole is greater than the sum of its parts. Dimensional diversifies not only in the amount of securities it holds (thousands) but in the range of capital market strategies it explores and develops. In this way, investors focus on the factors that drive investment returns, reducing excess and undesirable risk.
| The Benefits of Diversification |
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| Monthly data: 1980-2005, rebalanced monthly. |
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1Portfolio consists of 50% FTSE All Share Index and 50% MSCI World ex UK Index. |
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