- Why Dimensional
Diversification is an essential tool available to investors. It enables them to capture broad market forces while reducing the uncompensated risk associated with individual securities. We have constructed strategies that seek to draw heavily upon this philosophy.
We believe successful investing means not only capturing reliable sources of expected return but managing diversifiable risks and other risks that do not increase expected returns. Avoidable risks include holding too few securities, betting on countries or industries, following market predictions, speculating in areas like interest rate movements, and relying solely on information from third-party analysts or rating services. To all these, diversification is an essential tool available to investors. While it does not eliminate the risk of market loss, diversification does help eliminate the random fortunes of individual securities and positions your portfolio to capture the returns of broad economic forces.
Dimensional's strategies diversify not only in the amount of securities they hold but in the range of capital markets they explore and develop. In this way, strategies are designed to focus on the factors that drive investment returns while reducing excess and undesirable risk.
For many investors, the S&P 500 represents the first equity asset class in a diversified portfolio. Although the S&P 500 Index is diversified in large US companies, investors can benefit further by adding components. Take, for example, a portfolio that holds just US stocks (S&P 500 Index), a portfolio that holds just Japanese stocks (MSCI Japan Index), and a portfolio that holds both. As illustrated above, the diversified portfolio has not only provided a higher historical return than either alone, but it has done so with fewer negative quarters.
Fixed income investors also benefit from diversification among government and corporate issuers and across global yield curves. The illustration below features a US government bond index and a world government bond index hedged to USD. Adding global issuers to a US bond index substantially reduced overall volatility while the average returns were similar.
This is the power of diversification: the whole is greater than the sum of its parts.
Diversification does not eliminate the risk of market loss.