Importance of Diversification in Today’s Investment Climate

Michael Bilotta, ChFC®, CASL™

Chief Investment Officer, Senior Advisor

JNBA Financial Advisors

michael.bilotta@jnba.com

www.jnba.com

Topic: Wealth Management

“Tis the part of a wise man to keep himself today for tomorrow, and not venture all his eggs in one basket”
~ Miguel de Cervantes, Don Quixote de la Mancha, 1605

Given all of the uncertainty surrounding not only the investing climate, but also the economic and global environment worldwide, a strategic and tactical approach to diversification are now more important than ever.   In an effort to help address the implications future shocks may have on an investment portfolio, you need to ensure the building blocks are in place long before it ever appears necessary. 

Simply put, the rationale for diversifying a portfolio lies in the fact that no asset class or market performs well at all times.  Diversification is a means of hedging risk in the face of unknowable market movements.

The importance of asset allocation is the concept of correlation which is a statistical number measuring how the returns of two different investments move in relation to one another.  (i.e.  If unanticipated and high levels of inflation showed up tomorrow, which assets would stand to benefit and which would stand to be negatively impacted?)   In today’s environment, we have a multitude of headwinds as well as opportunities that need to be positioned  in the “right doses” to either protect, or more positively, take advantage of - inflation versus deflation, Stocks overvalued versus undervalued, slow growth versus outright double-dip recession, a strong dollar versus one suggested to be replaced as the world’s reserve currency, etc.  Luckily, while there is STILL no “golden goose”, there are numerous vehicles designed to help investors position themselves for the effects of varying environmental pulls on the economy and the capital markets. 

The global market downturn and subsequent recovery has reinforced the benefits of a long-term strategy, with each such strategy being one-hundred percent appropriate for the individual investor.  Although the gains may not potentially be as great in a strong bull market, the downside returns also should be much more diluted when market upheavals occur.  Often times, it is the fear of not participating in the unpredictable upswings that tends to derail strategic planning and puts people in the position of spending less, working more, or having to tell their children that their college fund was invested entirely in ABC stock whose value is down 50%.  

While no one can ever guarantee investment performance on any given strategy, one thing you can be certain of is that the markets will go up and go down.  One way investors can ensure that their portfolio won’t be wiped out in one fatal swoop is to diversify effectively.   While many think they are diversified by owning multiple holdings, if they all move in tandem, the diversification is ineffective.   Essentially, the practice of successful diversification, as strange as it sounds – is “being OK” underperforming in a certain environment so you can outperform in most others.  However, you can rest a little easier knowing that the environments in which you may outperform may also be the ones where others are facing those tough conversations.  

2010-09-15 23:00:00 -0600