When Harry Markowitz was awarded the Nobel Prize in Economic Sciences in 1990, the acceptance of Modern Portfolio Theory was assured. At its core, MPT states that investors should diversify their investments over multiple asset classes. This is the concept of diversification, technically defined as:
“A strategy that seeks to combine in a portfolio assets with returns that are less than perfectly positively correlated, in an effort to lower portfolio risk (variance) without sacrificing return.”
Balancing Risk and Return
One of the fundamental concepts of all investing is exemplified in this theory: maximize return while balancing risk. While the largest investment houses employ very sophisticated analyses and computer software toward this effort, the approach is still relevant to even the smallest investor. In fact, one of the major myths about diversification is that it requires extensive resources.
The value of diversification is that it helps even out the impact of market cycles that decrease values in some assets while increasing them in others. In other words, the basic expectation is that if one class goes down, the other will increase in value.
Understanding Diversification for Investing
If you are curious about the best way to handle your portfolio, it is worth your while to study and employ this concept of diversification. After all, they don’t give out Nobel Prizes for investment strategies that don’t work.
However, before you start that process, here are several facts and fantasies about the process of diversification:
Fact: Simply diversifying your portfolio does not ensure either full protection or maximum return. Although many investment advisers wish it was that simple, each investment in each asset class must be carefully selected to optimize any portfolio.
Fantasy: Hedge funds have all the answers. Although they get a lot of positive press, the mere process of investing in major hedge funds was proven to be a naïve form of diversification by the economic crisis of 2007-2008.
Fact: Precious metals are an integral part of any successful effort to diversify your portfolio. In fact, numerous studies show, “Financial portfolios that contain precious metals perform significantly better than standard equity portfolios.”
Fantasy: Equities always provide the greatest long-term return. While equities in the U.S. markets continue to be one of the greatest long-term investments, gold debunked its title during the ten-year period starting in 2000. Specifically, despite some declines in prices, an investment in gold has proven to be one of the wisest and most profitable investments of the 21st century.
Fantasy: Many investors, but not Jim Cramer, stay away from the gold and silver markets out of ignorance and fear. These concerns include the supposed risks of holding physical gold and silver, the lack of any interest or dividends, and even concerns over liquidity. All of these are irrelevant in today’s precious metals markets.
If you are serious about portfolio diversification and optimization, you’ll take steps to make sure precious metals make up a percentage of your assets. Learn more about diversifying your portfolio with our Free Precious Metals Investor Guide – Click Here