Diversification Among Asset Classes
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Diversification Among Asset Classes
Overview
In recent years, portfolio diversification has garnered significant attention, especially regarding the use of hedge funds as an alternative investment strategy. Hedge funds are often seen as a way to diversify because they aren't directly tied to traditional investments like stocks and bonds. However, a closer look reveals that despite using sophisticated tools like derivatives, controlling purchases, merger arbitrage, and venture capital, hedge funds still have strong connections to traditional markets and come with risks of illiquidity and high expenses.
Are Hedge Funds Right for You?
Whether hedge funds suit your portfolio depends on your risk tolerance, comfort with illiquidity, and investment objectives. Traditionally targeted at high-net-worth individuals, these unregulated assets are now reaching a broader audience looking to boost returns in low-yield environments. Some financial advisors suggest hedge funds to enhance portfolio performance, with advisory fees deducted from quarterly returns. However, recent performance has been mixed, prompting some managers to increase risk in pursuit of higher returns. As noted by Vikas Agarwal of Georgia State University, there's limited data available?"only about a decade's worth?"making it crucial to analyze hedge fund performance cautiously.
Diversification Strategy
Following the tech bubble in 2000, there was a shift from technology to real estate, energy, natural resources, bonds, and emerging markets. Long-term investors in these areas saw significant gains, with mutual funds in these sectors leading the market post-tech bust. Recently, the real estate sector cooled, prompting some investors to relocate their funds. Rather than attempting to time these market rotations, the key is to build a diversified portfolio that includes all asset classes.
Maintaining such a portfolio requires discipline, involving the acquisition and retention of both favored and out-of-favor assets. I recommend using dollar-cost averaging and reviewing performance annually. When checking statements or online resources, keep in mind that performance data is only a snapshot, and while year-to-date returns are valuable, analyzing 3- and 5-year returns can provide a more comprehensive view. This approach helps avoid reactionary decisions based on short-term market news.
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