04-13-2004, 07:34 PM
I'm trying to understand the 3x3 grid of investment "styles" which goes from Value to Growth horizontally, and from Small Cap to Large Cap vertically.
I understand the necessity of diversifying between Value and Growth investments, but what is the necessity of diversifying between Small-, Mid- and Large-Cap investments?
Is it really necessary to diversify to the extent of having all 9 boxes represented in the portfolio?
04-13-2004, 08:57 PM
I've never seen that. The nine squares I'm familiar with compare risk with return. the risk levels correspond roughly with company size: high-risk (small and medium caps), medium risk (large caps, blue chips), and low risk (bonds); the risk is usually assigned by services such as Morningstar based on the volatility of the holdings. Return is based on history. One does NOT diversify based on such considerations. Rather, one determines one's acceptable risk based on age, marital or family status, and the strength of other investments, and then selects funds that present the highest probable return consistent with the acceptable degree of risk. As a healthy 40-year-old man, I plan to retire in 25-30 years; this gives me a medium to high acceptance of risk; I have most of my assets in low- and mid-caps, but I also hold a healthy chunk in an income fund. My son's college plan is entirely growth funds, because he's 3 months old. The more conservative part of my financial plan is owning a house and buying life insurance -- if everything else goes up in smoke, all I need is enough income to make those payments, and I'm sitting pretty, relatively speaking.
Diversification is just a name for buying lots of different stocks, and if you have even one mutual fund, you're already very diversified. Buy into two different fund classes, and you're adequately diversified. Buy into funds that are appropriate for your level of risk, and you're wisely invested.
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