Variation is a fact of investment life. The asset class that provides the strongest return in one year is likely to be overshadowed the following year—or the year after that. The same is true of asset subclasses. In some years small caps outshine large caps. Other years the opposite is true. By owning both, you boost the potential for greater overall gain. Most securities have two types of risk: systematic and nonsystematic. Systematic risks affect an entire market or asset class. An example of interest rate risk is that almost all recently issued bonds lose market value when interest rates rise. Likewise, currency risk affects all non-US investments, whose return is vulnerable to the changing
value of the dollar against the currency in which the investment is denominated, or sold. And inflation risk reduces buying power when your return on investment is less than the rate of inflation. You can counter systematic risk with asset allocation, creating a portfolio of asset classes that are vulnerable to different risks, not all of which are likely to occur at the same moment. Bonds may suffer as interest rates fall, but stocks often excel. So does real estate. And that low correlation is exactly   Read more…