Diversification is a blessing and a curse. Diversification is a great way to manage risk in your portfolio without trying to time the market. It will also keep you invested during good times and bad. In a truly diversified portfolio you’ll own a mixture of investments with some up and some down. If all your investments are up or down, your portfolio isn’t diversified.
It’s human nature to want to own a portfolio of investment winners. Investors are quick to sell losing positions to chase the winners, a classic strategy of buying high and selling low. The Denmark stock market rose 23% in 2015 leading all developed markets. The Canadian stock market fell 24% in 2015 and was the worst performing global stock market. What do you think happened in 2016? In 2016, Canada was the best market by gaining 24% and Denmark was the worst by losing 15%. These two global markets exchanged places from 2015 to 2016.
This year emerging markets are leading the way while small cap stocks are turning in a sub-par performance and international stocks are outperforming U.S. stocks. Last year, the opposite occurred with U.S. stocks and small caps outperforming international investments.
Trying to identify the best investment from year to year is challenging, like trying to pick the best horse in a field of race horses. Sham was a great race horse in the 1970s finishing in the money 85% of the time but had the unfortunate event of being born in the same year as Secretariat. In thirteen starts, Sham finished first, second or third eleven times. Secretariat beat Sham in each of the Triple Crown races and won the Belmont Stakes by 31 lengths. To win in the long term, bet on more than one horse.
Here a few hot tips for your diversified portfolio.
- Own large and small U.S. companies. Since 1926, large stocks have generated an average annual return of 10% and small stocks have averaged over 12%.
- Own growth and value companies. Growth companies typically have stronger earnings and higher valuations than value companies. Growth and value companies will zig and zag depending on economic conditions. In the early stages of an economic recovery, value stocks will outperform but will lose momentum to growth stocks as the economy matures.
- Invest internationally. International markets make up 46% of the global market and often outperform the U.S. market.
- Invest in developed and emerging markets. Develop markets include the United States, Canada, Great Britain, Germany, Australia and Japan. Emerging markets include countries like Brazil, Russia, India and China.
- Buy Bonds. Bonds will generate income and provide a blanket of safety for your account. For example, when the stock market fell 37% in 2008, long-term government bonds rose 25%. The gain from bonds helped cushion the blow from falling stocks.
- Add alternatives. Adding a pinch of alternative investments will help diversify your portfolio. Alternative investments can include real estate, gold or oil.
- Hold cash. A cash holding will allow you to take advantage of emergencies and opportunities.
- Rebalance. Rebalancing your portfolio annually will reduce your risk and retain your asset allocation.
Here is a sample asset allocation for a portfolio consisting of 60% stocks and 40% bonds. Your 60/40 portfolio can have the following asset allocation.
- Large U.S. Companies = 25%.
- Small U.S. Companies = 10%.
- International Developed Markets = 15%.
- Emerging Markets = 5%.
- Alternative Investments = 5%.
- Bonds = 35%.
- Cash = 5%.
A diversified portfolio will keep you in the winner’s circle by giving you exposure to thousands of investments from around the globe so stay diversified my friends.
Don’t gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don’t go up, don’t buy it. ~ Will Rogers.
Bill Parrott is the President and CEO of Parrott Wealth Management. For more information on financial planning and investment management, please visit www.parrottwealth.com.
August 16, 2017