Diversifying reduces risk and increases return

For this simple illustration we will use 2 uncorrelated asset classes: US Equities and Money Markets.  

  • Bob has 100% of his $100,000 invested in a US equities

  • Sally has taken a 60/40 risk averse approach putting $60,000 in US equities and $40,000 in a money market fund.

In a sudden and sharp downturn, equities fall 30%.

  • Bob's portfolio would lose 30% of it's value, and 

  • Sally's portfolio would lose only 18% of its value [actually less, because she would also be earning interest on her money market funds].

While stocks are down, Sally is able to rebalance her portfolio.

  • Sally re-establishes her 60/40 ratio by moving $7,200 from her money market into US equities [buying low].

  • When the stock market returns to its original value, Bob would be back at $100,000, while Sally would have over $103,000 [actually more, because she would continue earning interest on her money market funds, and she would own more US equity shares that would earn additional dividends].

Summary of the benefits of diversification.

  • Lessens losses in a down marketreducing pressures that cause mistakes [selling when the market is down].

  • Enables you to buy low and sell high—automatically.

  • Increase earnings with money market dividends, and dividends from additional shares purchased during a down market. 

  • Losing less in down markets. 

  • Earning more in flat markets.

  • Using short and mid-term market fluctuations to produce higher returns in the long-term.



Benefits of Diversification 
and Rebalancing







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