It’s days like these that often confound even the most seasoned investor. Why? Because the most powerful word in the Dictionary of Finance and Investment Terms, "diversification," isn’t as helpful as one might like.
Diversification may be defined as the spreading of risk for the purpose of reducing it. You may spread risk across industries, regions, company size, and of course, asset class.
Different industries? Not today. Even traditional safer havens like health care, consumer staples and utilities found themselves with losses of 2% to 4%.
Different regions? The U.S. found itself in the enviable position of falling less than many of the international markets. The S&P 500 SPDR (SPY) fell approximately 2.5%. Meanwhile, the iShares S&P Europe 350 Index (IEV) shed 3.5%. Even some of the sharpest and steadiest ships in the international waters sank today, including the iShares MSCI Australia Index (EWA) with a 5.25% loss.
Different company size? I’ve been mentioning the divergence between large and small companies for weeks, noting that there’s little reason to risk your money in smaller companies right now. not surprisingly, the iShares Russell 2000 Index (IWM) gave up roughly 2.75% whereas the mega-cap large companies in the Rydex Russell Top 50 (XLG) shed a smaller 2%.
So now it comes back to asset classes. And yes, treasury bonds have been benefiting from a flight to greater perceived safety. The iShares Lehman Aggregate Bond Index (AGG) and the iShares Investment Grade Corporate Bond Index (LQD) have bounced off June lows and they were both higher today.
But a year-to-date and a year-over-year look at the bond market shows a negligible return. That would mean any diversification into bonds served only to drag on stock assets.
Specifically, if you enjoyed 15% gains in stock assets (year-over-year), then a 65/35 allocation to stocks/bonds may have given you a a 10% return. On a calendar year-to-date basis, a 65/35 mix may have produced only a 3.5% return through today’s close.
Now, I am not here to knock the place of bonds in one’s portfolio. And I am certainly not going to slam the importance of diversification as a concept. (It’s the magical word in investing, after all.)
What I do wish to point out is that diversification alone will not sufficiently reduce risk. A smarter, more balanced investor must have a plan to sell.
I’ve talked about how to sell in a variety of weblog posts. You might want to check out a few ideas in my July 19 piece… Can You Handle a Downtrend?
Disclosure Statement: As a Registered Investment Advisor, Pacific Park Financial, Inc. may hold positions in the ETFs, mutual funds and/or index funds mentioned above.