The two cornerstones of any investment strategy that, makes sense, are asset allocation and diversification. If you are not doing the correct diversification you are basically betting on some sector of the markets to do better than others. We are not in the betting game, we are investors, not gamblers.
The ultimate reason for diversification and asset allocation is to lower the overall level of up and down moves on your portfolio.
This helps(only so much) us as human beings from blowing up our financial plans when the next stock market drop comes along.
Asset allocation is the mix of Equities(stocks), bonds, and cash.
This is a note on diversification, here are the six things you should be aware of:
- Diversification spreads your money amongst different styles (ex. growth vs value), sectors (ex. banking vs technology) and geographies (ex. the US vs International). Each of these have historically had different cycles. Growth tends to cycle in contrast to value, large cap to small cap, also different areas international vs United States.
- The purpose is to help to suppress the short- to medium-term movements of the overall portfolio, while earning the full returns of everything over the long-term.
- Of course, in efficient markets, whatever suppresses volatility must commensurately suppress return. True diversification will always lower your return at any given moment. But this isn’t to be looked at as a bad thing; it’s actually proof that you’re on the right track. We are looking to keep your eyes on the prize: the full return of all the components over the long-term, actually over your lifetime.
- In a true diversified portfolio, something is always “underperforming.” That is exactly how you know you’re diversified.
- The last thing on earth a rational investor would ever do is to sell investments that are already DOWN to buy the ones that are already UP. This would have the effect of hurting your diversification. This is exactly what human nature wants to do (Human nature is a terrible investor). This is not investing it is making a bet. It’s one of the worst examples of what we preach not to do which is "performance-chasing".
- Rebalancing, helps us to take in some of the gains from the assets that have gone up a bit and add to the ones that have not done as well. Once again this contrasts what human nature, being the failed investor it is, wants to do which is the exact opposite of this proper investing strategy.
Diversification (and sticking to it) is a character trait. Like all good investment habits, month by month, year by year. We are the turtle not the hare.
Properly diversified clients set up according to their lifetime goals don’t get “great years”; instead they get a great life.
By utilizing diversification in this way we acknowledge an indisputable truth; although we have a very good idea what will happen over the long run (because we can look at the long term numbers), we never know what’s going to happen next.
And neither does anyone else; the difference is we should not ashamed to admit it.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.Asset allocation does not ensure a profit or protect against a loss.
Rebalancing a portfolio may cause investors to incur tax liabilities and/or transaction costs and does not assure a profit or protect against a loss.
Securities offered through LPL Financial, Member FINRA/SIPC