Diversification is an essential tool available to investors. It enables them to capture broad market forces while reducing the uncompensated risk associated with individual securities. We have constructed portfolios that seek to draw heavily upon this philosophy.
Several principals of Dimensional, out strategy partner, review the importance of the diversification principle in the video.
We believe successful investing means not only capturing reliable sources of expected return but managing diversifiable risks and other risks that do not increase expected returns. Avoidable risks include holding too few securities, betting on countries or industries, following market predictions, speculating in areas like interest rate movements, and relying solely on information from third-party analysts or rating services. To all these, diversification is an essential tool available to investors. While it does not eliminate the risk of market loss, diversification does help eliminate the random fortunes of individual securities and positions in your portfolio and to capture the returns of broad economic forces.
Our portfolio strategy diversifies not only the amount of securities the portfolio holds but in the range of capital markets they explore and develop. In this way, the strategy is designed to focus on the factors that drive investment returns while reducing excess and undesirable risk.
Fixed income investors also benefit from diversification among government and corporate issuers and across global yield curves. Historically adding global issuers to a US bond index substantially reduced overall volatility while the average returns were similar.