Modern Portfolio Theory is an investment methodology that begins with the premise that it’s less risky to invest in several low-correlation asset classes than to place all of one’s wealth in one asset class. It builds on the basic principle that diversification increases the likely return while decreasing overall risk.
The market is an effective information-processing machine. Each day, the world equity markets process billions of dollars in trades between buyers and sellers—and the real-time information they bring helps set prices.
The market’s pricing power works against mutual fund managers who try to outperform through stock picking or market timing. As evidence, only 14% of US equity mutual funds and 13% of fixed income funds have survived and outperformed their benchmarks over the past 15 years.
Some investors select mutual funds based on their past returns. Yet, past performance offers little insight into a fund’s future returns. For example, most funds in the top quartile (25%) of previous three-year returns did not maintain a topquartile ranking in the following three years.
The financial markets have rewarded long-term investors. People expect a positive return on the capital they supply, and historically, the equity and bond markets have provided growth of wealth that has more than offset inflation.
Academic research has identified these equity and fixed income dimensions, which point to differences in expected returns. Investors can pursue higher expected returns by structuring their portfolio around these dimensions.
Holding securities across many market segments can help manage overall risk. But diversifying within your home market may not be enough. Global diversification can broaden your investment universe.
You never know which market segments will outperform from year to year. By holding a globally diversified portfolio, investors are well positioned to seek returns wherever they occur.
Many people struggle to separate their emotions from investing. Markets go up and down. Reacting to current market conditions may lead to making poor investment decisions.
Daily market news and commentary can challenge your investment discipline. Some messages stir anxiety about the future, while others tempt you to chase the latest investment fad. When headlines unsettle you, consider the source and maintain a long-term perspective.
A financial advisor can offer expertise and guidance to help you focus on actions that add value. This can lead to a better investment experience.
Dimensional Fund Advisors is one of the world’s leading investment firms, managing assets and institutional asset class mutual funds exclusively for institutional investors and the clients of selected registered financial advisors.