Diversification for investment success

When we structure and monitor your investments, we diversify your portfolio in many ways. Diversification is a core principle of our firm.

It is clear that to grow your investments and outpace inflation, a portion of your portfolio needs to be invested in stocks.

However, we will never invest so much in any one company stock or bond that your financial future would be significantly impacted if a single company were to blow up or decline dramatically.

For your stock portfolio, we invest in mutual funds which are highly diversified. They are each invested in at least hundreds of companies, across a broad range of industries. For international and emerging market funds, there are maximum levels of exposure to countries and regions, as well as at the company and industry sector level.

We also broadly diversify your fixed income securities across numerous companies and industries. We would not have you own more than a few percentage points of your portfolio in any one company’s bonds, at most.

These principles are designed to use diversification to reduce your risk by avoiding over-concentration in any one region, idea, concept or stock. We cannot control the future, but we can use diversification as a method to control your risk.

Just owning a group of mutual funds does not ensure adequate diversification. Many times we have seen prospects or others who own many mutual funds, but several stocks are the major holdings throughout these funds. These people had numerous funds, but were not properly diversified. The set of mutual funds we recommend prevents this type of duplication. For example, you will not find Apple held in 4-6 of  the 12 funds that we may recommend for you. If you are not a client, we can analyze your accounts to determine how well you are diversified, by company, industry sector and geography.

The world is constantly changing. Technology and innovation cause companies to succeed and others to fail. It is very difficult to consistently predict which companies will do best in the future, especially over the long term. By being broadly diversified and using asset class funds, we enable our clients to participate in the growth of the US and worldwide economy, through owning companies of all sizes and industries.

Many investors focus their holdings on high dividend paying stocks. They feel they are diversified and think they are doing well, as they may own many stocks in various industries. However, we have seen numerous portfolios where these portfolios are lagging stock market benchmarks by huge margins over the long term on a total return basis. They are diversified, but by focusing on what we refer to as “legacy stocks” of the past decades, they are not doing as well as they could be from companies in various industries. Being diversified using our investment philosophy mitigates this dramatic underperformance of owning primarily legacy or high dividend paying stocks.

Diversification cannot prevent losses. Diversification cannot avoid broad declines when all global stock markets go down at the same time.

Diversification can also limit your upside. For example, by being broadly diversified, you would not have benefited as much if you had invested a large percentage of your portfolio in a few stocks, such as Facebook or Amazon which have a had huge long term gains. The tradeoff for diversification is less overall risk and less volatility. We think that is worthwhile in the long-term, given that you would own some of each of these stocks within the mutual funds we recommend.

Given that the future is always uncertain, we diversify your portfolio in an effort to compensate for this uncertainty.

Broad diversification enables you to avoid preventable investment issues, such as being highly concentrated in a single stock or industry, and then to see this stock or sector vastly underperform global benchmarks. Examples of this would be concentrated investments in energy in the past few years or technology stocks in the early 2000s.

We use diversification as another way to provide you with a better long-term investment experience. Diversification is a way we can strive to reduce your risk, as much as possible, through good planning.

This week’s takeaway: The more you own of any one stock or one sector, such as energy, health care or a few technology stocks, the greater the unnecessary risk you are taking. We recommend broad diversification for a greater chance of long-term investment success.

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