reduces risk and increases return
this simple illustration we will use 2
uncorrelated asset classes: US Equities
and Money Markets.
has 100% of his $100,000
invested in a US equities.
has taken a 60/40 risk averse
approach putting $60,000 in US
equities and $40,000 in a money
a sudden and sharp downturn, equities fall
portfolio would lose 30% of it's
portfolio would lose only 18% of its
value [actually less, because she
would also be earning interest on
her money market funds].
stocks are down, Sally is able to
rebalance her portfolio.
re-establishes her 60/40 ratio by
moving $7,200 from her money market
into US equities [buying low].
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].
of the benefits of diversification.
losses in a down market—reducing
pressures that cause mistakes
[selling when the market is down].
you to buy low and sell high—automatically.
earnings with money market
dividends, and dividends from
additional shares purchased during a
less in down markets.
more in flat markets.
short and mid-term market
fluctuations to produce higher
returns in the long-term.