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Does the term \u201cinvestment diversification\u201d make you want to skip this read?\u00a0 If so, all the more reason to continue! The diversification inherent in your investment portfolio heavily impacts your retirement goals.<\/p>\n
The technical answer on why pursuing a diversified portfolio is important: to<\/strong>\u00a0improve your investment portfolio’s risk-adjusted return<\/strong>.\u00a0 Whether you work with a financial advisor or not, you\u2019re often guided into a few misconceptions related to this topic, which I’ll highlight here.<\/p>\n Consider a portfolio’s diversification from two angles: amongst<\/em><\/strong> asset classes (i.e., equity, fixed income, alternatives, cash) and within<\/em><\/strong> asset categories.\u00a0 Examples include, but are not limited to:<\/p>\n I use Mutual Funds and ETFs in my model portfolios, which own a collection of individual positions in a particular category.\u00a0 These products charge a fee, which is not typically transparent to the retail investor.\u00a0 Let\u2019s touch on a couple of these topics in more detail.<\/p>\n Just because a fund owns a basket of securities does not necessarily mean it\u2019s \u201cdiversified.\u201d\u00a0 What if you own just two mutual funds, for example, and there is significant overlap in the underlying securities?\u00a0 That defeats this exercise’s purpose, and now you’re paying twice for the same position.\u00a0 Awesome.<\/p>\n What if you add 20 more mutual funds or ETFs to help mitigate this?\u00a0 Well, then the benefits of diversification start to diminish once you hit the 20 to 30 securities mark, according to E.J. Elton and M.J. Gruber, two academics and the authors of Modern Portfolio Theory and Investment Analysis. \u00a0It\u2019s like dark chocolate <\/strong>(replace as necessary) \u2013 the first few bites are great but eating the whole bar may not offer the same utility.<\/strong><\/p>\n This is the management fee that the mutual fund or ETF manager charges to run their portfolio.\u00a0 They are listed in the prospectus and on research tools, but not on your statement<\/strong>. This fee is deducted from the portfolios return and is in addition to what your advisor charges<\/strong>.\u00a0 \u201cActive\u201d funds have higher expense ratios than \u201cpassive\u201d funds, which mirror an index.<\/p>\n The industry\u2019s average internal expense ratio in their model portfolios is between 60-80 basis points or 0.60%-0.80%, but it can be north of 1%.\u00a0 A purely passive portfolio might fall somewhere between 10-20 basis points.\u00a0 My model portfolios fall in the middle at 30-40 basis points.<\/strong><\/p>\n\n
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What Do I Use?<\/strong><\/h5>\n
Collection of Individual Positions<\/strong><\/h5>\n
Internal Expense Ratio<\/strong><\/h5>\n
Other Factors to Consider<\/strong><\/h5>\n
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Please remember…<\/strong><\/h5>\n