The Wrong Way to Diversify

In the following video, author Jack Schwager gives some excellent advice on the meaning of true diversification to allay some investment risk. Another way to complement your risk hedging strategy is with strong dividend stocks. If you're interested in some of these dividends on your quest for high-yielding stocks, The Motley Fool has compiled a special free report outlining our nine top dependable dividend-paying stocks. It's called "Secure Your Future With 9 Rock-Solid Dividend Stocks." You can access your copy today at no cost! Just click here to discover the winners we've picked.

Brendan Byrnes: What do you think is the best way for investors to diversify? Obviously, there are a couple different schools of thought here.

You can buy a basket of 30 stocks and you get a bunch of different stocks, different industries -- an automaker, Ford; an energy company, [ExxonMobil]; a tech company, Apple, [Amazon.com] -- and you just create a bunch of these different individual stocks, and then, as you mentioned, there's index funds and then there are also mutual funds, maybe with low correlations, that you could use to diversify.

What do you think is the best way to go about it? Is it, again, up to the individual investor, or do you think there -- ?

Jack Schwager: Yes, but there the main message with diversification is, what people do wrong is they think of diversification in numbers, like if you're adding more assets, you're getting more diversified. I point out that actually, if you're adding correlated things, you might actually be reducing diversification.

I use an example if you were allocating to managers. For example, if you had five managers you were allocating to, using all different approaches, then you added 10 who were using a similar approach, that 15-manager portfolio ends up doing -- even though the managers are equal quality-- it ends up doing much worse, more risk, even though you've tripled the number of managers because you just added a whole group that act like one.

You've got to pay attention to how uncorrelated your assets are, not just what the number of assets are.


Read/Post Comments (0) | Recommend This Article (5)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2172319, ~/Articles/ArticleHandler.aspx, 11/25/2014 10:22:52 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement