Effective Diversification

Diversification Can Reduce Volatility

Harry Markowitz, a Nobel laureate in economics, proved in 1951 that diversification reduces risk, and that assets should be evaluated not by their individual characteristics, but by their effect on a portfolio. Through proper diversification, an optimal portfolio can be constructed to maximize return for any level of risk tolerance.

In essence, diversification is deliberate uncertainty recognizing that it is too difficult to know with particular subset of an asset class, or sector is likely to outperform another. Broad diversification seeks to capture the returns of all of the sectors over time but with less volatility at any one time.

The key to effective diversification is recognizing that different assets and all of the subsets of assets have varying ranges and patterns of volatility. Equities as a whole are less volatile than any one subset of equities. Additionally, different indexes that represent different sectors of the economy or the global market tend to react differently to market events. It is through the higher volatility of some subsets of assets and the exposure to different patterns of volatility that higher returns are possible without increasing the standard deviation, or risk of your overall portfolio.

At Winship Wealth Partners, we help our clients achieve the right risk-return tradeoff, providing broad diversification, with calculated exposure to compensating risk factors through structured investing.