I highlighted company-sponsored funds for utilizing target-date retirement funds and hindering the growth of your portfolio. While that strategy is not suitable for everyone because it lacks diversification, it raises the question: How can we create a diverse portfolio without sacrificing performance?
First, we need to identify the types of tools used for investing because they might be more diversified than you think. The most commonly used items are stocks, bonds, mutual funds, and Exchange-Traded Funds (ETFs). Stocks represent units of ownership in a company, offering upside potential and dividends. Bonds are units of debt in a company or government, paying interest over a set period and ensuring the value of your original investment. Mutual funds and ETFs are pooled investments that may include up to 500 various companies, aligned with an investing strategy or index. Traditionally, when building a portfolio before the emergence of mutual funds and ETFs, investors would choose uncorrelated companies to offset portfolio drawdowns. Conventional practice involved holding 20-30 positions. Nowadays, robo-advisors commonly employ model portfolios of 10-12 ETFs or mutual funds. However, the issue arises with over-diversification. For example, VOO, probably the most widely used ETF for robo-advisors, encompasses 500 companies. With a portfolio of 10-12 ETFs, you could end up holding positions in 6000 companies. To put this in perspective, the NYSE lists 8,000 securities available for trading. Diversification can mitigate portfolio drawdowns, but as the great Warren Buffet once said, "Diversification is protection against ignorance." If you lack the time to construct a portfolio and evaluate performance, seeking assistance from a professional is advisable. This can be achieved through a flat fee model or a percentage of accounts under management. There is no foolproof method to avoid drawdowns in a portfolio through diversification. Investing entails various risks: market, interest rate, or currency. Identifying your investing goals and devising a strategy to align with them is crucial to ensuring the suitability of your portfolio. Comparing your performance to others without considering their comfort level compared to yours is like comparing apples and penguins—it's illogical.
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