Understanding Diversification

 

Diversification means different things to different people. Most understand the concept of diversifying away from a single investment holding, or even diversifying into multiple asset classes. However investors are often not aware of the need to diversify on the basis of asset class correlation.

 

Every asset class has risk and return characteristics and correlation to other asset classes. By investing in asset classes which are negatively correlated, further diversification can be achieved.

 

Why diversify?

 

  • Asset class performance varies over time and is not easy to predict. A mix of asset classes is more likely to meet an investor’s goals.

 

  • Different asset classes perform differently. Combining them provides better risk/return characteristics. 

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