Market experts agree, and decades of investment experience has proven, that a diversified investment portfolio through effective asset allocation is the best way for investors to achieve the long term goals of their overall financial plan – and equities (including equity mutual funds) play a key role in achieving the highest returns for a given level of risk. Here’s how (and why) an appropriately diversified investment portfolio can help buffer market turbulence:
- Asset classes tend to move in different directions. By loading your portfolio with a single asset class, you concentrate your risk and limit your sources of returns. A well-designed, adequately diversified portfolio encompasses all asset classes which can offset the downward movement of one class with the upward movement of another.
- Nobody knows in advance which asset classes will outperform or underperform, and when. Because asset performance is constantly changing and the asset allocation process is dynamic and fluid, investors are best served by covering all the bases at any given time.
- Studies have shown that the correct asset mix offsets selection risk – making asset allocation, not individual investment selection, the major driver in investment returns. In fact, as much as 90 per cent of portfolio variability can be attributed to the choice of asset types, with only 10 per cent coming from the choice of individual investments.
- Since 1950, fixed income investments have generally reduced investment risk but have also lowered long-term growth. Over the same period, Canadian equities have produced the necessary asset growth to achieve long-term investment objectives1. The takeaway: Even conservative investors should allocate at least 25 per cent of their long-term investment portfolio to equities (including higher yielding equity mutual funds).
- The amount of risk in your portfolio depends on your personal tolerance for risk and your time horizon. For example, if you’re close to retirement, you might want to reduce risk to protect a portion of your investments from inevitable periods of market volatility.
1S&P TSX Composite vs DEX Long Term Efficient Frontiers (1950-2010)