Importance of Diversification
The best performing market or asset class varies from year to year – and there is not a way to predict the best performers in advance. Therefore, prudent investors diversify their portfolios to participate in the gains of top performers while mitigating exposure to the poorest performers.
In the early 1950s, Harry Markowitz laid the foundation for Modern Portfolio Theory by showing that proper diversification is not simply adding more investments to your portfolio, but combining assets that behave differently; specifically, those with less than perfect correlations.1 The optimal outcome is a portfolio of investment assets whose collective expected risk has been lowered without reducing the collective expected return.
Proper diversification does not eliminate risk, it minimizes risk for a given return expectation while improving the potential for a less volatile path towards achieving investment objectives.