Diversification is the one free lunch in investing, and yet so many investors turn it down.
By diversifying broadly across different asset classes, economic sectors and regions of the world, you avoid the risk of a catastrophic fall in the value of your portfolio that comes with being too heavily concentrated in one particular area.
As hedge fund manager Lars Kroijer explains in this video, it has never been easier to diversify than it is today.
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Hello there. It has been said that diversification is the investing equivalent of a free lunch. Research suggests that, not only is it the best way of managing risk but, over the long-term, also leads to higher returns. The good news is that index funds and other passively-managed investments have diversification built in. Here’s the investment author Lars Kroijer.
“I believe in index funds because you can very cheaply get exposure to a very broad array of industries, sectors, geographies and jurisdictions without really doing much yourself. It is better than buying A: individual stocks or even picking individual industries or countries.”
We’re always hearing about investors who bought just the right thing at the right time. But they’re actually in a tiny minority. Sure, you might get lucky – but why take the risk of being unlucky?
Lars Kroijer says: “Take the example, 20 years ago, that you had invested in just one market. If you’d picked the right market that would’ve been great. If you had picked the market that was en vogue at the time (namely Japan), you would’ve lost 75 or 80% of your money. If you had picked the whole world, which is what I advocate doing, you would have diversified the risk away of being unlucky and picking just one country, in this case Japan.”
Of course, this is the age of globalisation. Markets in different parts of the world are more closely correlated than they were before. So, have the benefits of diversification lessened?
“I’ll give the short answer and the short answer is yes. And why is that? Because companies are now more global, look at Google they operate in every country in the world, I’m sure; as does McDonalds and Phillips and all the other big companies. The short answer is the benefit of diversification is lessened. The cantor to that is though that 50 years ago, even when I was at University… not quite, in the early to mid-90s you couldn’t actually buy it. So you couldn’t actually easily get exposure to most of these countries. If you say: “Let’s buy some shares in India”, well 20 years ago you couldn’t actually do it. You could by the US, some countries in Western Europe, perhaps Japan. All these other diversifying markets were simply not available to you. Now they are. Just like back then, index investments like Vanguard were just really beginning to increase in size, but even back then they only had the US markets. Now they’re global. Use those benefits you can gain from that.”
That’s all for now. Thanks for watching.
We’ve shared Lars Kroijer’s insights before on TEBI, here are a few more examples:
Picture: Jimi Filipovski via Unsplash