An Optimal Portfolio
Though we can analyze cycles and trends in order to get a good idea of what lies ahead, we can never know for sure which investment or investment sector will outperform or when and to what extent economies will go up or down. Portfolio diversification is one of the strongest measures against this type of uncertainty.
Diversification moderates risk by combining a mixture of different types of investments with unique strengths and weaknesses into one single portfolio. The idea behind this strategy is that, over time, diversification will temper the gains or losses from one type of investment with the performance of another – helping investors better plan for the unexpected, and taking some of the fear out of investing.
"By combining assets that vary in response to forces that drive markets, more efficient portfolios provide higher returns than less well-diversified portfolios. Conversely, through appropriate diversification, a given level of returns can be achieved at lower risk."
David F. Swenson, CIO of Yale University's Endowment Assets and Investment Funds
Not all diversification options are created equal however. For years many portfolios were constructed in a way which attempted to achieve adequate diversification through a combination of stocks, bonds and cash exclusively. Unfortunately, as the Great Recession painfully proved, these efforts fail to combine assets that move independently of one another. In order to be effective, diversification strategies must select and incorporate investments together within a portfolio that behave differently in varying market conditions. In this way, investors are able to establish the right balance between income, growth and stability in both good times and bad.
Today, a growing number of investors and investment managers are pursuing opportunities within the alternative investment sector, such as investments in commercial real estate, in order to meet their portfolio diversification needs. That's because the risk and return characteristics of alternatives are unique compared to those asset classes which have historically tended to make up the bulk of retirement portfolios. Although there is no guarantee that any investment will achieve its objectives, when included into a broader retirement allocation plan, diversification into alternative asset classes may serve to better protect an investment portfolio from the unexpected swings of the broader market.