It is important to note that previous performance is not representative of future performance, but it does allow an investor to make an informed decision and compare performance. While not all risk can be eliminated, some can be minimized by diversification.Â
Everyone has a different investment approach, goals, risk tolerance, time horizon, liquidity, constraints, etc. Because significant differences exist among investors, there are important factors to be considered when implementing an investment strategy such as the individual objectives and any other important factors along with a due diligence process.
There are numerous ways investors can diversify their account. One of the most known and widely used is the life cycle asset allocation. The asset allocation is considered the most important decision made by investors. A good reference is 100 minus age. It is believed that as investors get closer to retirement age, the more risk averse they become, hence the change in allocation is recommended from more equities to more fixed income as they progress in the life cycle.
Total risk can be measured by the standard deviation and this type of risk can be diversified. Systematic risk on the other hand cannot! Beta measures systematic risk which cannot be diversified away, the beta for the market is 1.0. So, if the portfolio constructed has a beta higher than 1, it means it will have more price volatility than the market. On the other hand, if the beta is lower than 1, less volatility can be expected.
