RETIREMENT PUZZLE IF YOU CAN LOSE YOUR MONEY WHILE ALL AROUND ARE KEEPING THEIRS by Alex White, Head of ALM Research, Redington At its simplest, as an investor you want to make money.You’re trying to increase returns and reduce risk. In some of my earlier posts, I’ve covered how diversification can help with this goal; for example, diversifying a portfolio from one asset class to two (uncorrelated, equal volatility) asset classes would reduce the overall volatility by 30%. However, this can be reversed. If your portfolio is diversified from the market, it means it will behave differently from the market. Fundamentally, that means there will be times where the market goes up and your diversifying assets go down. In fact, the more diversifying your assets, the more likely and more extreme this effect will be. The table below shows the probability of underperforming a lognormal asset with a mean return of 4% and a volatility of 20% with an identically distributed, correlated asset.
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