Risk and Return are inseparable; Diversification is essential

One of the most damaging myths that Wall Street brokers spread is that somehow, someway, you can obtain high returns with low risk. This is objectively untrue. Different investments have different expected returns, largely based on the type of investment, (stocks versus bonds), and other recognized dimensions of risk. While risk is a necessary part of investing, portfolios can be structured for higher expected returns by taking advantage of known risks dimensions such as small cap, value and profitability.

Perhaps you have seen or heard some of the media ads pitching investments that “guarantee” returns without market risk, (mostly insurance based products). These ads appeal conceptually to the embedded desire investors have to achieve something for nothing. Risk and return cannot be decoupled. The quest for returns without risk can lead you down a rabbit hole very quickly and move you farther away from your financial goals, not towards them.

While risk is inescapable, broad global diversification is essential. When combined with a long- term perspective, (years instead of days), diversification enhances the reliability of investment outcomes.

We usually discuss the positive attributes of diversification in our review meetings. Often, we look at the best and worst performing asset categories each year compared to a diversified portfolio. With few exceptions, a diversified portfolio is rarely the best or the worst performer in a given year. As one of my colleagues likes to say “diversification means that you’re not going to make a killing, but you won’t get killed”.

Diversification allows you to execute discipline and stay invested in all types of market conditions. It acts as a “shock absorber” for risk. Do you have enough diversification? Do you have a good handle on your portfolio risk? Ready for a real conversation?

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