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 is the antidote. It washes away the random fortunes of individual stocks and positions your portfolio to capture the returns of broad economic forces.
For many Australian investors, the S&P/300 ASX Index represents the first equity asset class in a diversified portfolio. Although this index is diversified in large Australian companies, investors can benefit further by adding components. Take a look at the chart below, showing an example of three portfolios. The first holds just Australian stocks, the second is entirely composed of global shares (MSCI World Index) and the third holds half of each. You can see that while the diversified portfolio has provided similar historical returns as the Australian portfolio, it has done so with less volatility as measured by its standard deviation.
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.
This is the power of diversification: the whole is greater than the sum of its parts.
| The Benefits of Diversification |
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| *Annualized number is presented as an approximation by multiplying the monthly or quarterly number by the square root of the number of periods in a year. Please note that the number computed from annual data may differ materially from this estimate. All data is represented in Australian dollars. The performance presented is historical and past performance is not indicative of future performance. |