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5 Ways Diversification Eliminates FOMO and Regret in Investments

Investment can often be a high-stakes game filled with uncertainties, risks, and the constant fear of missing out (FOMO) or regret. However, the strategy of diversification might just be your ticket to a worry-free investment journey.

The FOMO and Regret Phenomenon

Investors often grapple with the fear of missing out (FOMO) and regret in their investment decisions. This fear can push investors to take hasty decisions, like increasing their exposure to a specific market or stock that has recently shown high returns. This phenomenon, known as recency bias, can make investors forget the fundamental rule of investment: past performance is not indicative of future results.

The Danish Stock Market Anomaly

Consider the Danish stock market, which has outperformed the US market over the past two decades, driven largely by Novo Nordisk, a single company that constitutes 60% of the market. Investors focusing solely on returns might be tempted to increase their exposure to the Danish market. But should they?

The Risk Factor

Risk-focused investors might feel uncomfortable with the increasing concentration of companies in their portfolios. The risk of absolute failure or future underperformance of a single company can lead to concern and regret. So, how can investors tackle this problem?

The Solution: Diversification

The answer lies in diversification. A portfolio that is well-diversified across different markets, sectors, and capitalizations (from mega to small companies) and tilted towards value-oriented stocks can effectively mitigate these risks.

Analysing Diversification: A Deeper Look

  1. Track the US equity market using the S&P 500 index.

  2. Track the developed markets (DM) by way of the MSCI World Index.

  3. Provide globally-diversified exposure to developed and emerging markets (EM), with tilts towards mid-cap and smaller companies, and value stocks.

Portfolio Weightings: Top 10 Companies

A comparison of the portfolio weightings of the top 10 companies in these funds can reveal intriguing facts. The US market is highly concentrated, with a third of the market made up of just ten companies. Diversifying into other developed markets improves diversification, with around one-quarter of the portfolio made up of the ten largest companies.

Spreading the allocation across emerging markets, smaller companies, and value stocks (which have higher expected returns) provides significant diversification.

Diversification: The Top 500 Companies

A look at the top 500 holdings in each of the three options shows that these companies represent 100% of the portfolio in the case of US equities, compared to only 50% of the diversified global equity option.

Effective Stock Holdings

Effective stock holdings provide a slightly technical measure of diversification. The calculation is based on the Herfindahl-Hirschman Index, a measure of market concentration. This index gives an estimate of the number of stocks that effectively represent the portfolio. It indicates that many investors would feel more comfortable with 479 stocks dominating their portfolio than just 60.

Diversification: The Way Forward

Diversification is crucial because investors own portfolios today and in the future. No one has forward-looking insight into which company’s shares are going to outperform. A well-diversified portfolio can help avoid both FOMO and regret, leading to a more prudent investment path.

The Bottom Line

Investors should remember that investments involve risks. The investment return and principal value of an investment may fluctuate, and past performance is not a guarantee of future results. However, with careful planning and a diversified portfolio, investors can navigate the complexities of the investment world with less fear of FOMO or regret.

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Final Note

The information in this article is intended only to provide general knowledge and does not constitute investment advice. It is the responsibility of any person wishing to invest to inform themselves of and observe all applicable laws and regulations.

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