On this week’s Tape Talk we’re talking all about diversification. While it can be an important component of any well-managed portfolio it is also often misunderstood. We’ll break through some of that misunderstanding by reviewing five common misconceptions we’ve seen when it comes to the discussion of diversification of your investment accounts.
But first, Headlines.
We take a look back at the previous week and the government shutdown that wasn’t. Over the week Washington scrambled to put together a deal and passed it Monday afternoon. This made for a brief and utterly non-event shutdown of the government which was far from the fireworks some expected. What happened and what does it mean for the markets here?
Five Diversification Myths
It Means Owning Lots (and lots) of Stocks
Diversification means more than just owning lots of different stocks or funds. In fact, equity diversification begins peaking out around 20-30 individual stocks. Instead, diversification should be more appropriately understood as owning different asset classes with different risk/reward ratios as well as varying correlations to each other.
Just because you diversified your portfolio once doesn’t mean you’re good to go. Investors need to reexamine their portfolio at least annually to ensure their allocation lines up with their desired risk level, allocation target, and required rate of return. This is because assets drift, diverge, and converge over time.
I’ll Get The S&P 500 Returns
While the S&P is the most talked about benchmark it’s far from a guarantee or suggestion that everyone can or should get the same returns as the index. In fact, unless you are investing solely in an S&P 500 index fund your return will likely vary from the S&P 500, sometimes by multiple percentage points. Since assets produce different returns, and you may hold many different assets, your return will be closer to a weighted average of your asset selection.
I’ll Just Buy Lots of Funds/ETFs
Just because you own a handful of different funds doesn’t always been you own different asset classes or investments. In fact, many funds in the same category have almost identical holdings. This means an investor might own 10 different funds but be no better diversified than if she simply held one of those funds. True diversification means knowing what you own, what each fund owns, and how each of those assets moves with the others.
It Removes Investing Risk
Risk is better understood as the potential to not reach your goal. In investing there are two types of risk; systematic risk and unsystematic risk. The later is found in individual investments (companies, bonds, small businesses, property, etc) and can be diversified away. The former is the nature of the market and can’t be diversified. In other words, if you own investment assets when the market goes through a major correction, recession, or crash, there’s always a chance those assets will fall, even alongside supposedly non-correlated assets.
Time For A Plan?
Are you unsure if your portfolio is diversified and allocated the way it should be? Are you investing without any idea what your required rate of return is or what your goals are? It may be time to get a plan. Learn more about our LIFE Plan process to discover how to align your investments with your goals and no longer simply guess when it comes to your money. Download our planning questionnaire HERE or contact us to get started on your personalized plan.