Most investors have heard a lot about Diversification and how to ensure you are invested across all asset classes. It is not as straightforward as some may believe and becomes a complex decision for even the best financial advisors. Why is it not that straightforward and why do some get it right and others do not?
The Complexity of Asset Classes: Different asset classes (stocks, bonds, real estate, commodities, etc.) have different risk and return profiles. Understanding how each asset class works and how they interact with each other requires in-depth knowledge and expertise.
Correlation and Risk: Assets may seem diverse but can still be correlated, meaning their prices move in similar directions. Proper diversification requires finding assets that are not just different but that perform differently in various market conditions, which is not always easy to identify and requires volumes of data and analysis.
Ever Changing Market Conditions: The correlation between assets can change over time. For instance, during a financial crisis, assets that were previously uncorrelated can suddenly move together, reducing the effectiveness of diversification. Responses to these changes are required.
Global Diversification Challenges: Investing in international markets can provide diversification benefits, but it comes with challenges that include currency risk, political instability, different regulatory environments, and unfamiliar economic conditions. International expertise comes in very handy and produces long term value.
Behavioural Factors: Investors may have biases or preferences (like favouring domestic over international investments) that can hinder effective diversification. The feeling that ownership of physical property may provide a false sense of security and growth is never actually measure correctly. Political viewpoints and falsie loyalties impact decisions, emotions like fear or greed also affect investment choices and timing of such choices, leading to an imbalanced portfolio and outcomes. Generational planning is also often not considered until it is too late. Always aim to use the same measuring stick, changing your measuring/ comparative criteria, may provide a false sense of pride in your lacklustre performing, self-managed portfolio.
Costs and Fees: Managing a diversified portfolio could involve higher costs, such as transaction fees, management fees, timing loss and opportunity costs, never-mind that in most cases, a self-managed portfolio results in unnecessary tax implications. Over-diversifying can also dilute potential returns without necessarily reducing risk.
Knowledge and Resources: Investors need a solid understanding of various markets and sectors to build a truly diversified portfolio. For individual investors, it can be difficult to acquire or access the necessary tools and data in a timely manner. You may be risk averse in personality, but your investment planning may not achieve your objectives without a varying investment risk profile.
Due to these factors and others, achieving real value diversification requires careful planning, continuous monitoring, and in most cases professional partners that follow an investment process aimed at providing clients with a scientifically designed suite of risk profiled investment portfolios that are robust, yet dynamic in terms of adapting to changes in investment market cycles.
Do get in contact with our Wealth Managers to find out more about RWM’s 11 actively managed, composite investment portfolios with risk profiles that are aligned to the risk and return you are aiming for.
Partnering with the best in the market is not optional, it is a necessity.
In reference to the Morningstar Article:
https://www.morningstar.com/portfolios/why-simpler-has-been-better-portfolio-diversification
Why Simpler Has Been Better for Portfolio Diversification. Broader asset class exposure doesn’t always pay off.
Amy C. Arnott, CFA
Apr 16, 2024
