Staying Diversified

Before money can be invested, the wise investor must believe in this crucial concept: don’t put all of your eggs in one basket. Asset allocation is the art of balancing risk and reward through the diversification of your investments into appropriate asset classes. It’s one instrument that helps to determine the appropriate blend between fixed and equity assets. It helps to smooth out the peaks and valleys that you find in the more volatile portfolio.

There are three ways to potentially pursue investment results: market timing, security selection, and asset allocation.

Market timing is trying to predict what an investment, an asset class or, the market will do before it does it. Timing the market is a difficult strategy. Not only do you have to avoid investing during market downturns, but you also want to make sure that you’re invested during the upswings. Often this means investing money when you are the least comfortable and taking money out when you feel the best about your performance.

Because the market is highly unpredictable and emotions tend to lead us in the wrong direction, I often recommend against timing the market.

Security selection – Many people believe that they know how to find the next “hot pick or hot dot” for investing, but predicting next year’s best performer is anyone’s guess. One year’s top performer could be the next year’s dud, and just because something did poorly the year before doesn’t mean that it will do well the following year.

Asset allocation is a process of determining the right asset mix for you. As you develop your portfolio, remember that there isn’t a cookie-cutter solution. Just because you’re in your 50s doesn’t mean that you should have X% in stocks and Y% in bonds. You have your own goals, risk tolerance, and amount of money to use for those goals. What you need to do is to find the appropriate blend of investments to achieve your desired return within your level of risk and suited to your time frame.

As you’re looking at investments, try to research all available asset classes. Your allocation could include small, medium, or large U.S. companies; small, medium, or large international companies; emerging markets; bonds; or investment real estate. If your portfolio is large enough, then you may look to expand your allocation by investing in sectors of the market or utilizing other asset classes.

Staying diversified – In his work on modern portfolio theory, Harry Markowitz found that only 1.8% of the average portfolio’s return is attributed to market timing, 5.6% of investment return can be attributed to security selection, and that an appropriate asset allocation accounts for 91.5% of a typical portfolio’s return.

As you can see, the key is creating a diversified portfolio and investing in that portfolio for the long term. I typically suggest that clients rebalance their portfolio on an annual basis to make sure that one portion of their portfolio hasn’t grown too large. By rebalancing, you’re essentially taking the best performer and selling while it’s high and moving that money to an area that is not performing as well and buying low.

If you’d like to learn more about your tolerance for risk, go to our website at Partnershipwm.com and click the Free Portfolio Risk Analysis button on the right side of our home page.