What Does It Take to be Diversified? INTRO: Most of us agree with the statement "don’t put all your eggs in one basket" and try to invest in a diversified manner; but what does it take to be truly diversified. Bruce Hagan, certified financial planner with RAI Investments and Corporate Securities Group is here to give us some insight. Q1: Bruce, when did the concept of diversification become popular? A1: There’s a Talmud quote approximately 2,000 years old that says “Let every man divide his money into three parts, and invest a third in land, a third in business and a third let him keep in reserve.” So it’s been around awhile. A more contemporary translation of this advice might read” Let every investor create a diversified portfolio that allocates one third to real estate, one third to common stocks, with the remaining one third allocated to bonds and cash equivalents. Q2: Would this three-part formula still be effective today? A2: Well, there’s no magic formula but let’s examine the rationale of this model. The one third allocated to fixed income mitigates some of the volatility risk inherent in the two thirds allocated to equity investments. Diversification across two major forms of equity investing with dissimilar patterns of returns further reduces the equity risk. The result is a balanced portfolio, tilted toward equities, appropriate for an investor with a longer investment time horizon who is concerned about risk and return. It’s a simple yet powerful asset allocation strategy that continues to work 2,000 years later. Q3: Within this framework is there even further diversification needed? A3: Yes and the key is to use multiple asset classes that are dissimilar. If you have 25 holdings and they’re all common stocks, you’re not very diversified. But, if you have those 25 holdings spread across U.S. stocks, international stocks, U.S. bonds, international bonds, real estate investment trusts and maybe even a commodities fund, you have a great deal of diversification. Q4: So you’re saying that some riskier assets should event be added to the portfolio? A4: When we construct a portfolio using multiple asset classes, we discover that portfolio volatility, over time, is less than the weighted average of the volatility levels of its components. That’s so important I’m going to say it again in a different way. If you had a portfolio of 4 distinctly different asset classes and on a 1 to 10 scale they had volatility of say 8,6,4 and 2 the mathematical risk level would be less than that. Q5: How can that be? A5: This occurs a result of the dissimilarity in patterns of returns among the components of the portfolio. When one’s performing poorly, another should be performing well. Q6: Now it seems understandable that diversifying can reduce risk, but don’t you also give up something in return doing this? A6: In any given year, you will not have as good performance than you would if you were lucky enough to pick the best performing asset class that year. The last few years the S&P 500 has outperformed a more diversified portfolio; but history indicates long-term performance is enhanced through diversification. The discussion offered above and in the movie should not be considered an endorsement by Florida State University. They are offered in the educational sense of providing thought-provoking information for our Web audience. Copyright shared with Florida News Channel (FNC), all rights reserved. Broadcast 5/5/00