One of the cornerstones of investing is diversification. We asked Mike Hemingway, Assistant Portfolio Manager, for his insights.
Talk about diversification. How do you define it? What does it mean to the average investor?
Diversification is the spread of assets among asset classes and individual securities to reduce the portfolios overall risk. There are thousands of securities available to investors used for diversifying. For the average investor, the more diversified you are, the less risk you incur. As a rule of thumb, we always advise our clients to avoid putting all their eggs in one basket. By embracing diversification, investors can make sure that they can weather even extreme market fluctuations more easily all while keeping an eye on their long-term goals and objectives.
How do Exchange-Traded Funds (ETFs) help with diversification?
ETFs are a tool that make it easy to diversify. ETFs are already made up of anywhere from 20 to 1000+ equities or bonds. They do diversification for you. But it’s not a one-stop shop: you can diversify across ETFs within a single asset class. There are myriad screens or filters that allow you to tailor your portfolio to your needs.
ETFs give us the appearance of having 10-15 positions, but in reality, that can be 2500+ companies.
What is a common mistake you see around diversification?
One common mistake is not being diverse enough. You can own equity in 20+ companies, but if they are all in the same industry, you are not diversified if that sector falls out of favor. Using assets that are not closely correlated provides stability within your portfolio and limits dramatic value swings. People may be tempted to go with just the big-name companies (think of the technology you use every day). Those big tech companies may not perform as well as another asset in a down market and rarely does one sector outperform other sectors year over year. Spreading that risk across different areas, helps to manage it more easily.
What are the risks of not being diversified?
You may find yourself subject to heart palpitations! If you want a roller coaster ride, don’t diversify! If you want a nice scenic route (twists and turns still included), diversify. You can avoid unnecessary levels of nonsystematic risk and effectively eliminate that portion of risk if diversification is done correctly.
What is the best piece of advice for someone looking to diversify?
Think out of the box. If you feel like you are not diversified enough, read a periodical you wouldn’t normally read. Pay attention to the ETFs being discussed or advertised in the media. And, of course, talk to your professional financial advisor because we are watching all that information every day and are prepared to give you advice that is in tune with your overall goals.