Preaching the Gospel of Diversification

I was just sitting down with one of my clients. I like to review with her every few months to make sure she understands what her investments are, how they are performing, and to make sure she is comfortable with them or if she has any questions.

With the roller coaster ride the stock market has taken over recent weeks, she was bracing for the worst. On the other hand, I was excited to show her that there was almost no volatility in her account plus the additional dividend that she has been drawing on for income!

This leads to a very important point. It is all fine and good if you want to dump all of your money into the index fund of your choice, but you better be able to ride that beta wave. Sometimes you will enjoy the ride while other times you will be white-knuckling it! That is why we financial planners are always preaching the Gospel of Diversification. It is the positive risk-adjusted return that we are after. The risk-adjusted return, as you know, is that return you receive that considers the level of risk (volatility, beta, modified deviation, etc.) your investment has.

So essentially, by keeping your returns constant (or hopefully giving them a bit of a bump) while at the same time reducing the risk, you have a higher risk-adjusted return. How do you find this Holy Grail of a portfolio? Diversification! You want to make sure your investments are not going to react the same under the same economic and market conditions. By including a mix of investments (stocks, bonds, real estate, commodities, etc.) that are not correlated you can generate different streams of returns and you can achieve higher risk-adjusted returns. Also, don’t just stop at asset allocation, but diversify your strategies (passive, active, macro, trend following, long/short, etc.).

If you haven’t paid much attention to diversification over the past decade, you really should consider it now. The market benefited from easy monetary policy, but that policy is shifting. Central Banks are diverging on their respective courses of action. Inflation has arrived as a real headwind. There are geopolitical threats. Lions, tigers, and bears, oh my! Make sure to protect your downside.

Disclosure

Securities offered through Securities America, Inc., Member FINRA/SIPC. Advisory services offered through PFG Advisors. TruWest Wealth Management Services, TruWest® Credit Union, Securities America, and PFG Advisors are separate entities. Securities, insurance, and advisory offered through Securities America, PFG Advisors or their affiliates are not NCUA insured, no credit union guarantee, no credit union deposits or obligations, may lose value.