A Market Lacking Diversification
Correlations have increased across the market, but a few bastions of diversification remain.
We've all heard the saying, "Don't put all of your eggs in one basket." The idiom doesn't raise any eyebrows; it's intuitive. If you drop the basket, you break all of your eggs. If, on the other hand, you place half of your eggs in a second basket, dropping one basket renders only half as much culinary carnage. If only in a very simple and cutesy manner, the phrase speaks to a profound investment doctrine: diversification.
With regard to the egg idiom, the driving intuition is downside protection. Diversification allows one to significantly limit the potential for catastrophic loss. With regard to financial assets, however, short-term losses are generally not catastrophic. The interesting point is that there are benefits to diversification, even in the case that assets perform well over time.
Abraham S.H. Bailin does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.