Why investors need to diversify? What is the rationale for asset allocation?
Market movements are unpredictable. Market leaders can, and often do, fall out of favor. This uncertainty can be intimidating for investors seeking to build long-term wealth. The fact is, even the most experienced investment professionals are often unable to foresee exactly where the markets will be headed. But what investment professionals do know is that there is often a cyclical nature to these movements.
Market rotation occurs on many levels – not just among the major asset classes, but also among different subclasses of investments within each category. Every asset class and subclass exhibits differing risk and return characteristics over various time periods. Therefore, spreading investments among several asset categories with different characteristics allows for more consistent performance under a variety of economic backdrops.
Over time, a well-diversified portfolio of investments allows investors to take advantage of gains in strong-performing asset classes and reduce the impact of underperforming asset classes, thereby lessening the portfolio’s overall risk exposure and providing more stable-and possibly better-returns.
What is a Core-Satellite Approach?
Many investors have adopted a core-satellite approach to portfolio construction, which provides a solid framework for implementing an asset allocation model. Establishing a core portfolio that is highly diversified among asset classes, market capitalizations and regions can help protect investors during market downturns, while participating in positive markets.
Investors can enhance and further customise their core portfolios by adding shorter-term, tactical, “satellite” investments, which are designed to opportunistically take advantage of market trends or special investment situations.
Investors should value flexibility, maintain diversification and be very value-oriented. In conclusion, the core-satellite approach helps investors to move beyond the basic diversification. The “core” can provide a relatively stable income stream while the “satellite” is better positioned to capture the upside of the market. This will be an all-weather coverage portfolio that is available for everyone.
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