Diversified Investment is More Reliable

When faced with the multitude of selected funds, what should one do specifically when investing?

For most people, investing in a portfolio of active funds rather than in a single fund manager is more reliable.

Compared to investing in a single fund, diversified investment has the following three advantages.

Advantage One: Reduce the Personal Risk of the Fund ManagerInvesting in index funds is less dependent on the fund manager because index funds replicate the index and select stocks according to the index's rules, focusing primarily on the investment value of the index.

Investing in actively managed funds is essentially investing in the fund manager, and it's important to consider the manager's investment abilities.

Therefore, the personal factors of the fund manager represent the greatest risk.

For example, a fund manager may have their own career plans, which could involve job-hopping or starting a private equity fund.

They may also cease managing the original fund due to health conditions or retirement.

If the fund manager is replaced, the fund's investment strategy and style may change accordingly, which can impact our investments.How can we reduce the impact of a single individual?

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We can create a fund pool, stock a group of excellent fund managers, and make investments in a combined manner, thereby reducing the risk associated with a single person.

For a vivid example:

For instance, in a sports team, they won't send just one player onto the field during a game, nor will they send all the players from the team onto the field.

Instead, they carefully select the players who perform better and decide which players to put on the field based on various conditions such as the characteristics of the opponent, the field environment, and so on.During the competition, adjustments will also be made based on the performance of each player. If a player gets injured, a substitute from the reserve team can be used to replace them.

Thus, if a fund manager resigns or there is a risk, we can choose another fund manager of the same category to step in. There is no need to worry about the investment being interrupted.

Regarding how to select excellent fund managers, it has also been introduced in previous articles.

Advantage Two: Reducing Volatility RiskWhen constructing a portfolio, we can choose from a variety of different investment styles for diversified allocation. At the same time, for the same investment style, we also diversify across different industries. This can effectively reduce the overall volatility risk of the portfolio.

A-shares have the characteristic of style rotation. Different investment styles have different phases of gains and losses.

- Sometimes value style performs well;

- Sometimes growth style performs well.

A-shares also have the characteristic of large-cap and small-cap rotation.

- Sometimes large-cap stocks perform well;

- Sometimes small-cap stocks perform well.• Sometimes small-cap stocks perform well.

If one only invests in a single asset class, the volatility can be quite high, which can be psychologically challenging for investors to bear.

By diversifying investments, the volatility can be reduced, which can improve the experience of holding funds and help investors make long-term investments.

Advantage Three: Provides More Sources of Income

In general, there are three sources of income from investing in actively managed funds: overall stock market returns, returns from stock fund stock selection, and returns from choosing excellent fund managers.

▼ The Largest Source: Overall Stock Market ReturnsThe most fundamental and largest source of returns comes from the overall stock market gains.

This return can be observed through the CSI All-Share Index.

The CSI All-Share Index covers all listed companies on the A-share market and is a representative index that reflects the overall performance of thousands of listed companies in the Shanghai and Shenzhen markets. Over the past decade or so, the long-term historical average annualized return rate is approximately 10%.

On this basis, stock fund stock selection can bring excess returns.

▼ Return Enhancement: Stock Fund Stock SelectionThe thousands of listed companies on the A-share market are not all profitable, among which,

- some have strong profitability;

- some have weaker profitability;

- and some are even losing money.

Stock funds do not buy all companies but go through a stock selection process, aiming to enhance returns by choosing a subset of stocks with stronger profitability.

This return can be observed through the total index of stock funds.

The total index of stock funds reflects the overall performance of all stock funds in the A-share market. Over the past decade or so, the long-term historical average annualized return rate is about 14%, which is 3% to 4% higher than the CSI All-Share Index.Active Selection: Curating Outstanding Fund Managers

However, not all stock funds in the A-share market have consistently good long-term performance.

Among the vast number of actively managed funds, those with good long-term returns generally have a stable investment style, such as value, growth, or balanced styles.

If we carefully select fund managers with a long track record, relatively good annualized returns, or those with potential from various investment styles, we can further achieve excess returns.

The long-term annualized returns of some outstanding fund managers can be higher than the overall average returns of stock funds, potentially exceeding 15%.

Diversified Portfolio Investment: Allocation and Rebalancing

Diversified portfolio investment involves spreading investments across different assets and regularly rebalancing to maintain the desired asset allocation.On the basis of the three sources of returns mentioned above, if we construct a portfolio and invest in a basket of funds through a combined approach, we can also use the investment techniques of diversification and rebalancing to further increase the returns, achieving an effect of "1 + 1 > 2".

Summary

When investing in funds, it is necessary to construct a portfolio, which can help us invest more confidently, calmly deal with the risks associated with individual fund managers, enhance our investment experience, reduce the risk of volatility, and at the same time, we can use more investment strategies to increase the returns.

For experienced investors, they can invest in different funds on their own to construct a portfolio.

If one wants to save time and effort, they can directly opt for ready-made advisory portfolios, which will help everyone build a good one.Why can diversified allocation and rebalancing reduce volatility risk and bring additional returns?