Alpha West Capital Founder Joshua Westerman: Why Portfolio Diversification Is So Important

By: Get News

Spreading investments across various types of assets can minimize the risk associated with any particular asset. This reduces a portfolio's overall risk and volatility. The main objective is distributing investments across various asset classes to reduce individual risk. Seasoned investors like Josh Westerman believe such a diversified investment approach strives to secure long-term returns while decreasing risk gradually. 

Understanding portfolio diversification can be likened to the proverb 'don't put all eggs in one basket.' The goal is to ensure that even if the public market undergoes fluctuations, the investor possesses alternate investments that can endure these changes and provide varied avenues for returns concurrently. Here is why asset diversification is essential.

What Does Diversification Mean?

Diversification involves holding various assets that yield different performances over time, ensuring that no single investment or category dominates. Experts like Joshua Westerman believe that a well-diversified portfolio comprises a handful of individual stocks from various sectors in stock investing. However, diversification extends beyond stocks. It encompasses other assets like real estate, bonds, certificates of deposit, funds, and even savings accounts.

Each type of asset behaves differently as the economy expands or contracts, each offering unique potential for profit and loss:

-  Stocks present the possibility for the highest return over the long term, yet their value can swing noticeably in shorter periods.
-  Funds are typically diversified because they often contain a multitude of investments. However, some funds may specialize in a single sector, such as consumer goods companies, meaning the level of diversification can vary.
-  Bonds generally provide more consistent returns with a predetermined payout, but their value can shift as interest rates rise or fall.
-  Government treasuries and CDs offer steady growth based on the interest rate or other agreed terms without any fluctuation in value.

The essence of diversification lies in the fact that these assets do not move in sync. As some assets increase in value, others may stay stable or decrease. Over time, the leading performers may become the underperformers, and vice versa. This lack of solid correlation among assets is what makes diversification attractive.

What's the Importance of Diversification?

Various types of investments react uniquely to diverse economic and market scenarios. Josh Westerman understands that diversifying across asset classes and investment types can help minimize investment risk.

Take, for instance, the correlation between U.S. large-cap stocks and bonds, which stands at 0.26. This suggests that similar factors influence 26% of these two asset types' returns, whereas 74% of the factors affecting their returns do not share a strong link.

This implies that bonds might exhibit a contrasting performance when U.S. stocks suffer negative returns due to their minimal correlation. Different asset classes could have higher or lower correlations on a broader scale.

Spreading funds across various investments opens up exposure to a broader array of outcomes, which can be beneficial in the following ways:

-  It lessens the risk of being heavily invested in a security or sector that suffers a significant loss.
-  It enhances the likelihood of maintaining some exposure to high-performing investments.
-  It serves as an effective strategy for reducing risk. Predicting which assets will excel or plummet in the future is often challenging or impossible, making investing solely in one area or asset a gamble.

Moreover, diversification can also moderate portfolio volatility, the frequent rises and falls. When an individual has numerous investments, some might appreciate while others depreciate (or depreciate less than some of the most volatile assets). These varying trends could balance each other out or soften the blow from market movements, providing a more steady return.

Diversification provides a straightforward method to stabilize returns, potentially enhancing them too. Investors can choose from an array of models to determine the level of diversification in their portfolio, ranging from a simple all-equity portfolio to one that encompasses a wide range of assets, each with its unique risk and reward profile.

Disclaimer: This press release may contain forward-looking statements. Forward-looking statements describe future expectations, plans, results, or strategies (including product offerings, regulatory plans and business plans) and may change without notice. You are cautioned that such statements are subject to a multitude of risks and uncertainties that could cause future circumstances, events, or results to differ materially from those projected in the forward-looking statements, including the risks that actual results may differ materially from those projected in the forward-looking statements.

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