Building Resilient Portfolios: The Power of Diversification

Executive summary:

  • Diversifying a portfolio means spreading the investments across a variety of asset classes, industries and geographies.
  • Diversification can help reduce the risk of a concentrated portfolio that would be vulnerable to news impacting a specific asset class or geography.
  • Diversification can help smooth out a portfolio’s returns.

The concept of diversification is well-known. The adage “don’t put your eggs in one basket” simply states why diversification is vital in many aspects of one’s life. But it is especially so in an investment portfolio that is intended to help fund a future goal—such as retirement.

Diversification is a strategic approach in which investments are spread across a variety of asset classes, industries, and geographies. This can help reduce concentration risk, which is when one asset class—or even a handful of securities—can come to dominate a portfolio. The problem with holding a concentrated portfolio is that it is vulnerable to any bad news that impacts that asset class or those stocks.

Additionally, diversification may help smooth out returns in volatile times, since different asset classes tend to react differently to economic and market events. That may lead to higher returns over longer time periods, and it may help investors avoid the pitfalls of emotionally based investment decisions.

Let’s look at concentration risk first.