Diversification and Starndard Deviation:

      When the word diversification is used many different meanings can come to mind. First there is the diversification among different types of investments: checking accounts, mutual funds, stocks, real estate, futures, ect. Second is diversification within certain investment vehicles like mutual funds. While these are not the only subjects in diversification, they are two of the most common. The second of the two is the diversification I want to discuss with this special report.

    Being The No-load Fund Advisor, it should come as no surprise that I want to talk about diversification within mutual funds. Why diversify, the two best reasons are 1.) to increase safety and 2.) reduce the standard deviation on your returns. Watch it Garry. You're talking like a investment guy again. Just stay with me and everything will be explained.

    Diversification increases your safety. We've all heard the saying don't put all you eggs in one basket. A mutual fund by design invests in many different securities. By purchasing a mutual fund the investor becomes instantly diversified. Instead of owning one or ten stocks the typical stock mutual fund may own 50, 100 or more stocks. This is important diversification. If one of the companies owned runs into trouble then there are 99 more to take up the slack. This is important but still not the area I really want to cover. The standard deviation of returns is the area of diversification I want to cover.

    Standard Deviation of return conceptually works the same whether the diversification is among different stocks or different markets. I will use the different markets in this discussion because it is a service we provide at the No-Load Fund Advisor that very few investment advisors do. That way I can use this article again in a brochure some day.

    Standard Deviation of return or just Standard Deviation can be best illustrated by an example. Look at the table 1, there are two set of date, lets pretend they are returns from investment advisors.

Table 1

     Both sets have the same average return of 20% per year, however, set A has a standard deviation of 40 and set B's standard deviation is only 3. The standard deviation tells us how close, on average, each separate element of data, perhaps yearly investment returns, is to the average. In other words, standard deviation gives us a measure of how close and consistent the actual separate elements of date are to the average. So why didn't I just use consistent instead of standard deviation? Because consistent is not an investment word and this is an investment news letter. Actually, because standard deviation tells us much more about the data that makes up the average then the average alone ever could. In table #1 the average long term return is the same between A and B, however, the degree of risk associated with those returns is dramatically different. Which portfolio do you want your money in? If you need money some where with in the period of time covered then what you would get out would differ dramatically. Thanks Garry. That was really interesting, no really, we mean it..

      O.K., I know that it is not earth shaking news; but, here is the point. When we diversify throughout different market places (bonds, domestic stocks, European stocks, gold, international bonds, ect.) we can increase our safety, our returns and lower the standard deviation of those higher returns. Take a look at chart # 1.