Just a quick post today showing an example of portfolio diversification in action.
Portfolio Diversification in Action
Diversification is recommended by every financial advisor. What this means is investing in different asset classes (US stocks, international stocks, US bonds, emerging markets, etc.) so you are spreading out, and hopefully lowering, the risk in your portfolio.
Yesterday’s (June 3rd, 2016) market moves give a great example of diversification in work. Below I use the actual percentages we had allocated in our portfolio as of that date. But I’ll use a $10,000 investment base to make the example fairly simple to see and understand.
The S&P 500 ended the day down .29% yesterday. Our investment account ended up .38% though. How?
Below is a chart I made of our investment portfolio’s results for the day.
You can see that the bottom line is that it gained .38% for the day – which means a difference of .67% (from the S&P drop to the portfolio’s rise). Of course every day is different, and past performance doesn’t guarantee anything for the future, but this is a great example of diversification working.
When coaching people in personal finance, we often educate on investing principles and practices. This includes explaining diversification and why it is a good idea.
Looking At The Above
The EFT ‘VEA‘ is a Vanguard ‘developed markets’ fund, so it holds investments from solid companies all over the world.
The ‘VWO‘ ETF is a Vanguard ’emerging markets’ fund, so it holds investments from companies in up-and-coming countries that might be positioned for big future growth.
Investing part of your portfolio in funds that aren’t tied solely to the US market means that something happening only in the USA (like job reports coming in worse than expected – which happened yesterday) will only impact a small part of the overall fund.
In yesterday’s case the funds had lower results on its US holdings but gains in others – giving a net gain overall for those specific funds. And since almost half (46.9%) of the portfolio has exposure to companies outside of the US, the worse-than-expected US jobs report only minimally impacted the overall portfolio.
On the date in this example, our portfolio’s diversification certainly worked as planned.
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