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Portfolio diversification: What do you get in return?

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Portfolio diversification is one of the most recommended investment strategies. However, following the economic meltdown in 2008 many mainstream investors are questioning the usefulness of the approach.
 
One can understand why. When you set up a portfolio and have your investments decline in more than double the value, one is going to start asking some serious questions.
 
Not only that, some retirement funds lost up to 40% of their value during the economic turbulence of the sub-prime crisis.      
 
So what is the whole point? If portfolio diversification is meant to protect your investments, it doesn’t appear to be doing a great job.
 
►There are five important points I’d like you to keep in mind:
  1. The good news: Diversification works by reducing investment risk. That’s a fact. It also prevents you from having to actively seek out high performing shares, a task which has eluded many professional asset managers.   
  2. The not-so-good news: A diversified portfolio doesn’t guarantee you a return, nor does it guarantee you protection. I like to refer to this as ‘maybe money’. You may see a return or you may not. 
  3. The not-so-good news: The strategy only works under certain conditions. Investors must learn to live with the fact that during market meltdowns or crashes, diversification will not help protect your investments. But it may help limit your losses during bad times.     
  4. The not-so-good news: Portfolio diversification only works over the long term. And by long term, I mean many years. Let’s say your portfolio gets whacked by a market crash in five years time. You will be 55 years old. Assuming you retire at 65, the question you need to ask is whether 10 years is enough time for your investments to recover their losses as well as generate enough profit to see you through retirement.
  5. The not-so-good news: A diversified portfolio will almost never beat the next diversified portfolio. If you are following a strategy designed for the masses you must expect the average. Is an average return good enough for financial success? Well, that depends on your definition of financial success.
► To sum up
  1. Diversification helps to retain investment value, not guarantee it.
  2. Novice investors rely on diversification. According to one of the world’s most successful investors, the approach is a key replacement for ignorance.    
  3. Wealth creators focus on growth, not diversification. They do this by accumulating specific income-generating assets. Monthly income is key, not ‘maybe money’.     

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