Simple Explanation of the Investment Portfolio Diversification Concept

 

Illustrating the importance of diversification one can compare it to a large windowpane.  Suppose you had a giant picture window in your living room. Sure, it’s big and it’s beautiful, but what happens if it breaks? This huge window, your only window, would be very expensive to repair. You’d probably be wishing you’d had one large window, with several smaller panes, that way, if one pane broke, it would be significantly easier and far less costly to fix. The same is true for your Investment Portfolio. 

 

Diversification helps to protect you in the good & bad times, and makes it much easier - financially & emotionally - to recover from setbacks, particularly in bad times! Effective diversification, namely holding assets of different classes that move in opposite directions from one another in differing and changing market conditions, is the proper way to diversify.

 

The Fundamentals of Investing:

 

I.  There is no such thing as "short-term investing." The term "short-term investing" is an oxymoron. Put bluntly, a short-term financial focus is speculation, not investing. Investing is a fundamental commitment of your capital to the pursuit of greater goals in your life.

II.  Valuation still matters. If you begin to believe "it's different this time," you're wrong. When valuations are far above historic levels, there's good reason to be concerned. Good companies may remain good companies, but they may not continue to be good stocks. When this basic principle of investing is ignored, you'll eventually pay a price.

III.  Asset allocation is a diversification strategy that works. It doesn't offer a guarantee against short-term market losses, but it's an effective investment risk-management tool. Sector concentration, no matter how attractive the sector appears, no matter how compelling the arguments, is still speculation.

IV.  There's no opportunity for return without some risk. If you don't see or understand the risk, keep looking because it is there. Once you find it and understand it, it may be acceptable, but until you identify the risks, they are unacceptable.

V.  Most dollars flow into high performing investments after the performance has occurred. The single most abused tactic is for investors to chase last year's performance. A disciplined investment plan and investment selection criteria are critical if you want to avoid making this mistake.

VI.  A well-balanced portfolio should be diversified among the major asset classes. Cash. Fixed Income. Large & Small Companies. Growth & Value. Domestic & International. The only guarantee is that some of these areas will periodically disappoint you, but you never know which ones or when. Your plan will succeed only if you stick to it and remain invested across several asset classes.

VII.  Years of high returns can be completely reversed by one bad year, that's why you shouldn't use short-term criteria to judge long-term results...that can lead you to unknowingly creating a very high-risk portfolio. Ultimately, consistency is more important than an occasional "home run."

VIII.  Traditional rules of investing are still true. While they can be adjusted periodically to fit finer points of the current economic environment, never abandon the core principals of diversification, sound values, patience, following a sound plan, and maintaining a long-term perspective. Know the rules and know when you are breaking them.

IX.  Raw information is not knowledge. Knowing just the facts won't necessarily make you any wiser.

X.  Market timing doesn't work. Moving in and out of markets based on any anticipated changes in price, as opposed to fundamental changes in value, is speculation -- not investing. 

 

Final Note: Investing your serious money requires discipline, patience, objectivity, and a clear, documented investment policy (adapted from CBS MarketWatch-Loeb-40601).

 

For these and other compelling financial & investment planning guidance, please contact us now.

 

- We welcome working, as a team, with your legal & tax professionals -

 

[Disclaimer:  we do not provide tax or legal advice -- you are advised to consult your own
tax and legal professionals regarding such issues.]

 

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