Golden rule number four – diversify systematically
In the fourth in our series of five golden investment rules, we look at the importance of a fully diversified portfolio and how to ensure you actually achieve genuine diversification.
“Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas” – Paul Samuelson, Nobel Prize winning Economist
In reality, long-term investing should be rather boring and dull, with a structured and systematic approach to asset allocation underlying it. People who purport to have an amazing investment opportunity, or a hot stock pick aren’t really investing, they are simply gambling – and usually with your money not their own!
Now, clearly, some people may be comfortable gambling, and may be prepared to take high levels of risk. However, we would always advise our clients to keep the majority of their investable assets in a fully diversified portfolio of stocks, gilts, bonds and cash. If you would like to gamble or select one individual stock over another, then have a separate, smaller ‘Vegas’ fund, which you are prepared (and can afford) to lose.
Academic research backs this up. Risk and return are highly correlated and numerous academic studies have shown that the more risk you take, the more return you should expect to receive over the longer term. The price you pay for this additional return is increased short-term volatility and therefore the structure, asset allocation and mix between riskier and safer assets is critical.
A structured investment portfolio should therefore also seek to control risk, as far as possible, and be aware of exactly the risks that are being taken. Systemic risk, which is the risk associated with being invested in a particular asset class (i.e. stocks or bonds), will always be part of a structured portfolio and the mix between such assets should be the way a portfolio controls this risk. By diversifying widely across industries, companies and sectors as well as internationally, you are reducing other non-systemic risks and increasing the prospects of securing the maximum return for the amount of risk you take (essentially getting the most bang for your buck!).
Diversifying doesn’t just mean holding lots of funds. Many managed funds simply replicate an index, so a number of funds may duplicate the same holdings. We recently met a client who had a portfolio containing eight separate internationally managed funds. When we ran our analysis it turned out that there were less than 500 individual holdings, as many of the stocks were replicated across all the funds. To achieve genuine diversification, you need to spread assets both across domestic markets and internationally and ensure duplication does not restrict your diversification.
Investors within the Moore Stephens Intelligent Investment strategy benefit from holdings of over 20,000 individual stocks, which helps to ensure genuine diversification across all sectors and regions. This diversification has meant that our clients’ portfolios have suffered minimally during the recent volatility surrounding Brexit.
We are happy to provide initial meetings to discuss our investment approach. We promise not to make them too boring or dull!
Look out for our next Intelligent Investor bulletin, where we will highlight our fifth and final golden rule.