Diversifying into Multiple Markets and Within Investment Types
by John Jagerson Asset allocation does not have to be complicated. Current market products and cost structures make self-management and asset class diversification more achievable than ever before. In this article within the asset allocation series we will walk through the decision between utilizing individual securities to achieve asset class diversification or ETFs and indexed mutual funds. While both options are perfectly reasonable, we can show that the bias will almost always shift towards ETFs and funds, especially for the small investor. This article will discuss the reasons why. 
Diversification is a multi-layered issue. There is horizontal diversification across asset classes and another layer of vertical diversification within each asset class. For example, one of the asset classes we are using within our model portfolio in this series is stocks. Investing in just a single stock will not optimize the benefits of diversification in the same way investing in 12-40 stocks will. Within each asset class you will have to spread your risk across more than one security and this can be difficult for small investors. Doing this one security or stock at a time has one major disadvantage - costs. Buying 12-40 individual stocks is certainly possible but commission costs may become prohibitive. For small traders this issue is exacerbated because commission costs become a larger percentage of the total investment. Alternatively, a low cost ETF or indexed mutual fund can provide exposure to many stocks within a single purchase and commission. In fact, it is possible for an individual investor to use indexed mutual funds to execute a portfolio strategy like we have described and pay no commissions. The other issue that investors will need to deal with is access. For example, in the portfolio we are constructing within this article series we have included commodities as one of the asset classes to increase its diversification. Traditionally, when investors think about commodities they think about the futures market. However, investing in futures requires a futures margin account. A futures account comes with its own costs and margin and balance requirements that may be prohibitive to small and mid-size investors. Fortunately investing in commodities, bonds, stocks and real estate can all be done through ETFs or indexed mutual funds. This reduces trading costs, increases sizing flexibility and makes it possible for individual investors to access several asset classes within a single account. ETFs and indexed mutual funds always come with some costs but these are usually much smaller than the convenience and benefits of using them. Next: Choosing Your Mix and Deciding What To Buy
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3.25 Copyright (C) 2007 Alain Georgette / Copyright (C) 2006 Frantisek Hliva. All rights reserved." |
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