By creating multiple paths to success, diversification provides superior returns to our portfolios--and to our lives.
In suburban Connecticut, near where I live, two towns sit next to one another. One is Greenwich, CT, a community known for its upscale homes and shops, as well as its concentration of hedge funds. Just a couple miles south on U.S. Route 1 lies the town of Port Chester, NY, a not-so-upscale community that has become a haven for immigrant groups. Recently, when my wife Margie and I went out to eat, we chose Port Chester.
When we first moved to the area, we were surprised to learn that foodies from New York City flocked to Port Chester, not the affluent communities of Fairfield County, Connecticut. Having lived in the region for nearly a decade, I no longer find that surprising. It's not just the authenticity of the food, but the staggering variety within and across restaurants that brings people to the area. The sheer diversity appeals to most any palate.
We are familiar with the idea of diversification in financial markets. It has been called the only"free lunch" available to investors. By spreading our assets across a variety of markets and strategies, we are able to harvest a broad set of returns. Thus, when some of our investments perform suboptimally, others can bring profit. Our total returns may or may not exceed the returns from a concentrated bet at any point in time,.
Note that diversification is a dynamic, ongoing process, not just a one time selection. When one group of assets has performed well in a portfolio and others haven't, the portfolio's composition loses its balance. By rebalancing the assets--selling some of the winners, buying some of the losers--the diversified investor, in Viskanta's terms, becomes a"contrarian".
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