It’s been said that diversification is the investing equivalent of a free lunch, since it allows you to manage your risk while getting higher returns.
The good news is that according to research, index funds and other passively managed investments like ETFs (Exchange traded funds) have diversification built in.
Yes, we’ve heard of people who were able to buy the right individual stock or sector at the right time, but they are few and far between. You can learn more about the free lunch of indexing by viewing the latest FWB video by clicking on this title: There is such thing as a free lunch and it’s called index investing.
Indexing beats picking individual stocks or sectors
The video, which runs three-and-a-half minutes, points out that using index funds to diversify equity exposure around the world is easier and more effective than attempting to pick individual stocks or even identifying promising industries.
And while it’s possible to buy the entire world’s stock market through a single fund, investors shouldn’t take that for granted. As investment author Lars Kroijer relates, 40 or 50 years ago you would have been hard pressed to be able to buy into most markets outside North America, Europe or Japan.
However, picking single countries or industries can be fraught with risk if you make the wrong call or are just plain unlucky. As Kroijer reminds us, someone who bet on Japanese stocks at the wrong time would have suffered losses of between 75 and 80%.
At one point in the video, Kroijer does suggest that as more companies become global in their scope (like tech giants Apple or Google/Alphabet), the benefits of diversification have lessened somewhat.
Even so, there are few free lunches in investing so you owe it to yourself to investigate this one. If after watching the video you want to learn more, download the free guide, 12 Essential Ideas For Building Wealth.