Is Diversification Dead?

Even though The Bunny is long gone, I’m still finding pieces of fake Easter basket grass all over the house. I’m not sure why we bothered to put it in our daughter Vela’s basket anyway … it’s not like it really protected the handful of chocolates and jelly beans.

Of course, a lot of investors are feeling the same way about the old “diversify, diversify” mantra these days. Even though they padded their portfolios with various investments, nearly every one of those holdings has lost value over the last year or so.

End result: Broken nest eggs and broken confidence in fundamental investment strategies.

You can see it all over the major news headlines. Popular opinion is shifting, and the concept of diversification is really getting put under the microscope. Many are writing it off as the “fake plastic grass” of the investing world … something that looks nice on a brokerage statement, but doesn’t protect a darn thing.

So is that it? Is diversification dead? Is it just a hold-over notion from a bygone era?

My answer: No way!

In fact, during a radio interview last week, the host told me about his personal friends … people who had built great fortunes by buying and holding blue chip stocks like GE (GE) over multiple generations. He said much of their wealth has evaporated in short order, and asked if that didn’t prove that nothing was safe these days.

As I pointed out to the interviewer, building wealth like that is a two-way street. There’s no implicit guarantee that any stock - no matter how blue chip - will maintain its value. I don’t care if it’s been trending up for decades. Take a look at the U.S. automakers and you’ll see my point.

In my opinion, anyone who has their entire fortune invested in a single stock is virtually asking to lose it.

Sure, the absolute best and fastest way to build wealth would be to find one home-run stock and let every penny ride on it. And there are real-world examples. Consider anyone who held Altria over the last 50 years or bought Berkshire Hathaway, Wal-Mart, or Microsoft way back when.

Keeping all your investments in one basket is a recipe for disaster.

Regardless, I wouldn’t suggest keeping your entire net worth in any one investment, even if it’s been a tremendous performer.

I’m not saying that buying and holding is the wrong approach. Rather, I’m suggesting that you’ve got to take some money off the table and put it into other assets along the way, particularly if the investment has had a rather substantial run up.

The Same Holds True for General Asset Classes:
Never Rely on Any One Investment Category

As you probably know, U.S. stocks have been the best performing asset class over very long periods of time. And that’s precisely why I firmly believe you are best served by putting a healthy portion of your portfolio into stocks, particularly the dividend-paying variety.

However, that doesn’t mean you should put ALL your investment dollars into stocks. I always tell my Dividend Superstars subscribers to consider their portfolio of solid dividend stocks - which cover many sectors and include foreign companies - as just one part of their overall investment approach.

For starters, you should always have a healthy amount of cash stashed in a very safe, liquid place. You never know when the need will arise, and you want to ensure access to those emergency funds at a moment’s notice. Consider this fund separate from your investment accounts, and tap it only when needed.

You should also consider bonds an integral part of your overall financial plan. Right now, I’m seeing some interesting categories out there.

For example, I’ve previously discussed my thoughts on inflation-protected bonds such as TIPS. I continue to believe those bonds make sense, especially given the prospect for renewed inflation down the line. But as I’ve been warning, some of the TIPS funds I follow have begun to show signs of life, and are breaking out of their trading ranges. So don’t wait too long to add them to your portfolio.

Meanwhile, I’m also seeing some interesting developments in the corporate bond markets - everything from investment quality companies to junk bonds. While some of these areas are certainly speculative, I’m beginning to like the risk-reward scenarios and the nice yields out there.

And because I’m not ready to call this bear market dead, I also think inverse exchange-traded funds can continue to provide good hedges against your long positions.

What About the Idea that Diversification Failed Investors in 2008?

There’s no denying that many assets lost value during this brutal bear market. But they have done so at markedly different rates.

Among stocks, the performance of some dividend payers has differed wildly from the broad market indexes.

And bonds have generally held up better than stocks, with Treasuries even handing early investors capital appreciation.

Gold has been volatile, but its trend has generally been up throughout the financial crisis.

Plus, the more important point is that different asset classes may RECOVER at different rates going forward. Stocks typically rally very sharply when bear markets end. Meanwhile, Treasuries will very likely hand out substantial losses to less-than-nimble investors.

My point is simple: Don’t mistake a general downtrend in all assets to mean stocks and bonds are now interchangeable.

Investment categories - and the global economy - may very well be more correlated than ever before. But isn’t a matter of just picking any old investment and hanging on for the ride.

Paying close attention to your asset allocation is as important as it ever was. In fact, this is the ideal time to revisit your needs and expectations and to make changes as necessary.

Because various assets have declined at different rates, you may very well discover that you now have too little invested in stocks and too much in bonds!

I know how crazy that sounds, and all the reasons for being worried about putting your investment dollars into anything other than cash right now. But at least give it some thought, and try to use history - not emotion - as your guide.

In my opinion, the importance of a diversified, well-padded basket is more important than ever. And the simple act of rebalancing will do wonders for protecting and building your wealth safely and consistently.

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