Diversification is One of the Few “Free Lunches” in Finance

I love collecting checks…

A few months ago, a restaurant on the Atlantic Coast sent me a check for several thousand dollars. I know food and wine, but I’m no restaurateur. I know just enough about restaurants to know that they’re usually bad investments…

But five years ago, I funded a restaurant. The owner was a man I trusted who made delicious food. The place became a local success with multiple locations. From my end, I put in no work and collect thousands a year. It’s about 10% a year on my investment.

I have to admit, I enjoy the fact there’s a check coming in… And I enjoy the knowledge that I made a good, income-producing investment nearly as much as I enjoy the amount of money.

My goal is to teach you to do the same.

So if you have some cash that you want to turn into consistent checks or deposits to your brokerage account, you need to know how to maximize that yield while minimizing risk…

Don’t get caught up in the “reach for yield.”

This is still the era of low and negative interest rates around the world. It’s hard to earn much from your savings today in the typical “safe” investments…

In my Income Intelligence newsletter, we have found some high-yielding assets that are less known to investors… A few of our model portfolio positions deliver income of more than 7% a year. But with those few exceptions, reaching for yield often comes with more risk.

The conventional wisdom is, if you can collect 8%, your investment will be volatile. If you can collect 10%, you’ve taken a speculative position. And if anyone says they can guarantee a “risk free” 10%, you may be getting a pitch from a con man.

We want to build a portfolio that works in all markets with minimal risk to capital. To do so, we must set reasonable goals.

That’s why we start with the best income investments available and use some simple portfolio theory to boost our yield without taking on excessive risk.

We can put together a diversified portfolio that returns a consistent 5% per year. And that payout doesn’t keep us from collecting capital gains as asset prices rise. The key to finding the right mix comes maximizing the return you can generate per unit of risk…

The easy way to do this is to add assets that aren’t correlated.

Think about this scenario… Take an asset that returns 5% a year but may vary widely in price in any given month.

By adding an asset that returns the same 5% yield but moves opposite the original asset, you can combine them in a portfolio. Now you can get the same 5%, with less risk…

This is why diversification is called one of the few “free lunches” in finance. By combining uncorrelated assets, you can get safer returns without sacrificing anything.

In the real world, it’s not this simple. We don’t have assets that are guaranteed to return given amounts or ones that move exactly opposite each other. But we can get close.

Most investors should spend a lot more time thinking about their investments as a portfolio that works together – rather than as a collection of ticker symbols that might go up.

We’ve been fortunate to enjoy a nine-year bull market. But over the next 10 years, your investment portfolio will have a rockier path than it has had in the past five.

In short, we can all use a little more money coming in the door, whether to pay the bills or to spend on luxuries.

However, if you go out and buy a high-yielding fund, be sure to think about how it works together with the rest of your portfolio. If you don’t, you’re likely missing out on free money.

Here’s to our health, wealth, and a great retirement,

Dr. David Eifrig

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Source: Daily Wealth