Conventional Wisdom Supports Diversification
Here are the opening lines on the website of “FutureAdvisor.
Future Advisor is an online investment advisor that automatically manages your investments to help you do better with your money. FutureAdvisor takes into account your unique situation and risk tolerance to give you the right stock/bond split and right mix of assets for your situation. FutureAdvisor gets you to your ideal asset allocation and rebalances automatically. This locks in market returns and protects you against crisis. Broad diversification helps capture these long-term returns of the market and reduces risk.
“… right stock/bond split and the right mix of assets for your situation” = Diversified Portfolio.
Here it is… the benefits of diversification all summed up in nine words
“...locks in market returns and protects you against crisis.”
Academic Support For Diversification
There is no shortage of academic support for Diversified Portfolios. The theory of diversification has been well documented in theory. The seminal paper by Brinson, Hood, and Beebower (henceforth BHB), “Determinants of Portfolio Performance,” published in 1986, concluded that asset allocation is the primary driver of a portfolio’s return variability for broadly diversified portfolios.
Vanguard published a paper confirming Wallick et al. (2012) showed that the asset allocation decision was responsible for 88% of a diversified portfolio’s return patterns over time.
Here is an analysis of both their works:
Brinson et al.’s (1986) most important contribution was to attribute a portfolio’s return variability to indexed static asset allocation policy, security selection, and market-timing components. The authors showed that, on average, the actively managed pension funds they studied had been unable to add value, either through market-timing or security selection, beyond their static indexed policy returns. This result was consistent with the observation that indexing outperforms a significant portion of active portfolios in equity and bond markets (Philips, 2012)
Broadly diversified balanced funds with limited market-timing tended to move in tandem with the overall financial markets over time in all four countries studied. Our empirical analysis, as originally performed by Brinson and colleagues, illustrated the significance of a broadly diversified asset allocation maintained through index funds.
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