During times of pronounced volatility (like we\u2019re seeing now), investors often try to find new ways to neutralize how market gyrations impact their portfolios. This can mean selling down stock positions, owning fewer stocks, shifting asset allocations to favor bonds or even looking to new asset classes like real estate.<\/p>\n
These tactical changes to investment strategies are almost always reactionary <\/em>in nature \u2013 owing not to changes in market fundamentals, but rather to shifts in personal sentiments. In other words, they\u2019re emotionally driven, which is the exact opposite of what they should be in the investment world.<\/p>\n Diversification is Time Tested, Yet Investors Still Challenge It – Frequently<\/strong><\/p>\n To me, the most optimal method for neutralizing volatility is the same method I used 20 years ago when I began my investment career: diversifying<\/em>. Over the years, I\u2019ve come to think of diversification like I do exercise. In spite of all the monumental medical advancements developed over the years, exercise still reigns supreme as one of the best things a person can do to care for their long-term health – it worked just as well 50 years ago as it does today. <\/em><\/p>\n Diversification, to me, is precisely the same timeless key to successful investing. It worked just as well 50 years ago as it does today, yet investors regularly abandon it as a strategy at critical times. It\u2019s puzzling.<\/p>\n When the going gets tough in the markets, as it could for a few weeks yet, remember that diversification provides these three long-term benefits:<\/p>\n Captures Returns from Different Markets While Limiting Risk from Any One – <\/strong>clients who advocate for owning fewer stocks\/positions (see below) often forget a key point: there\u2019s no way to know with certainty if you\u2019re betting on the outperformers. <\/em>If you concentrate your portfolio in certain areas of the market, sure – you create the opportunity for outperformance, but you also leave your portfolio susceptible to disproportionate downside if you\u2019re wrong.<\/p>\n Isn\u2019t There Such a Thing as Over-<\/em>Diversifying Though?<\/strong><\/p>\n I\u2019ve had some clients raise concerns over being too<\/em> diversified \u2013 owning too many positions to the point they believe they are diluting their upside potential. But owning a more concentrated portfolio with fewer positions not only (generally) creates additional risk, it also does not necessarily ensure you will outperform a well-diversified portfolio over time.<\/p>\n Data from a J.P. Morgan study conducted from 1994 \u2013 2012 underscores this point. Portfolio A was invested in just three positions: 55% in the S&P 500, 15% in the MSCI EAFE, and 30% in the Barclays Capital Aggregate (U.S. Bonds). Over that 18 year period, Portfolio A generated returns of 7.43% with a standard deviation of 10.80.<\/p>\n Portfolio B was more broadly diversified, investing across eight asset classes\/styles versus the three in Portfolio A. It had 8% in Equity Market Neutral, 8% Commodities, 8% REIT, 22% S&P 500, 9% Russell 2000, 13% MSCI EAFE, 4% MSCI Emerging Markets, and 26% Barclays Aggregate. Investors who don\u2019t like owning too many stocks or too many positions would likely prefer Portfolio A over Portfolio B, citing that Portfolio B would likely dilute returns over time (by virtue of being over-<\/em>diversified). The opposite held true in fact:<\/p>\n Over the same 18 year period, Portfolio B produced a 7.72% annualized return, with a standard deviation of 9.87. It had<\/em> more positions, greater returns, and lower risk. <\/em>The proof is in the pudding.<\/p>\n Bottom Line for Investors<\/strong><\/p>\n Investors often make changes during volatile times to feel as though they\u2019re doing something about it. But what many don\u2019t always realize is that they are usually just substituting one risk asset (or type of risk) for another. In the case of the investor who sells down equities in favor of holding more cash and\/or bonds, they are often unwittingly creating an entirely new type of risk for their retirement: the risk of running out of money.<\/p>\n The bottom line is that, in order to generate the type of long-term returns that most retirees are looking for (equity-like), you almost always have to accept a certain amount of risk\u2026and with that risk comes volatility. The key is not to take steps to avoid the risk altogether, but rather to manage the risk<\/em> where possible. And historically, the best way to do that has been through diversification.<\/p>\n Past performance is no guarantee of future results. Inherent in any investment is the potential for loss.<\/span><\/p>\n Zacks Investment Management, Inc. is a wholly-owned subsidiary of Zacks Investment Research. Zacks Investment Management is an independent Registered Investment Advisory firm and acts an investment manager for individuals and institutions. Zacks Investment Research is a provider of earnings data and other financial data to institutions and to individuals.<\/span><\/p>\n This communication is for informational purposes only and nothing herein should be construed as a solicitation, recommendation or an offer to buy or sell any securities or product, and does not constitute legal or tax advice. The information contained herein has been obtained from sources believed to be reliable but we do not guarantee accuracy or completeness. Zacks Investment Management, Inc. is not engaged in rendering legal, tax, accounting or other professional services. Publication and distribution of this article is not intended to create, and the information contained herein does not constitute, an attorney- client relationship. Do not act or rely upon the information and advice given in this publication without seeking the services of competent and professional legal, tax, or accounting counsel<\/span><\/p>\n","protected":false},"excerpt":{"rendered":" During times of pronounced volatility (like we\u2019re seeing now), investors often try to find new ways to neutralize how market […]<\/p>\n","protected":false},"author":1,"featured_media":4122,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[59,60,63,71],"tags":[],"class_list":["post-2966","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-financial-professionals","category-institutional-investors","category-mitch-on-the-markets","category-private-client-group"],"acf":[],"_links":{"self":[{"href":"https:\/\/zacksim.com\/blog\/wp-json\/wp\/v2\/posts\/2966","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/zacksim.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/zacksim.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/zacksim.com\/blog\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/zacksim.com\/blog\/wp-json\/wp\/v2\/comments?post=2966"}],"version-history":[{"count":1,"href":"https:\/\/zacksim.com\/blog\/wp-json\/wp\/v2\/posts\/2966\/revisions"}],"predecessor-version":[{"id":11515,"href":"https:\/\/zacksim.com\/blog\/wp-json\/wp\/v2\/posts\/2966\/revisions\/11515"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/zacksim.com\/blog\/wp-json\/"}],"wp:attachment":[{"href":"https:\/\/zacksim.com\/blog\/wp-json\/wp\/v2\/media?parent=2966"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/zacksim.com\/blog\/wp-json\/wp\/v2\/categories?post=2966"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/zacksim.com\/blog\/wp-json\/wp\/v2\/tags?post=2966"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}\n
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