The Importance of Diversification

We often talk about the importance of diversification towards building long-term wealth. It is a hallmark of AFT Trivest and we employ it in all of our portfolios. To perfectly demonstrate this, JPMorgan published a paper showing the performance of all the stocks in the Russell 3000 index (a benchmark index which tracks the entire US stock market) from 1980 to 2014. While the index increased 49-fold over the 34 year period, a shocking 40% of companies in the index suffered a catastrophic loss.

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A catastrophic loss was defined as when a stock lost 70% or more, and never recovered. This type of loss would be devastating to a small concentrated portfolio, and at 40% of all stocks you are nearly a 50-50 chance to pick one of them. On the other hand, a small number-7%, showed gains of 2050%. But despite their small number, they carried the overall index to a nearly 50 fold gain!

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Based on this analysis it seems clear that the key to success is to own enough of the market to the point where you guarantee some of the companies you are invested in (through the index) will die off, but in their place will be the successful companies which will more than make up for those losses. Looks like there actually is an upside to losing money!

http://read.jpmorgan.com/i/371035-eotm-special-edition/8

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