Efficient Diversification: The Key to Success

Diversification
Diversification

A diversified portfolio which captures the right blend of market indexes reaps the benefit of carrying the systematic risk of the entire market while minimizing exposure to the unsystematic and concentrated risk associated with individual stocks and bonds, countries, industries, or sectors. The only risk that remains is the risk of the market itself, a risk that must be taken in order to capture market returns.

As capitalism has expanded throughout the world, it has become increasingly important to allocate a significant portion of one's portfolio to international and emerging markets securities. In the 1970's, the U.S. comprised more than 68% of global equity value, but today it comprises about 50%1. Investors achieve the benefit of increasing diversification and capturing the expected returns of global capitalism by investing in index funds comprised of international developed countries and emerging markets countries in risk-appropriate doses.

An additional important aspect of diversification is diversifying across time. When investors maintain a globally diversified portfolio for long periods of time, they are able to maximize their ability to capture the complete range of returns that are offered by the global markets. Index portfolios with a high exposure to stocks require a longer holding period than fixed income portfolios in order to maximize the probability of achieving an expected outcome.

Investors should think of their portfolios as an investment in global capitalism. This hypothetical stock certificate represents an investment in Capitalism, Inc., showing estimates for year-end 2013 of total market value, sales, profits, number of CEO's, and number of employees who work for an investor who buys a globally diversified index portfolio. With a total market cap of $41 trillion, more than twelve thousand CEO's worldwide, and over 72 million employees selling products in 192 countries, it is not reasonable to believe that Capitalism, Inc. will go out of business. And if it did... your money would be worthless.

    -1 Dimensional, "Global Market Breakdown: June 2014," (2014)
Step 11DiversificationCapitalismStock Certificate