We are all aware that portfolio winners rotate position from time to time. Leaders have a habit of becoming laggards. “Must own” darlings become “forgotten” names. Winners vacate the “winner’s circle.” As the timeless saying preaches, don’t put all your eggs in the same basket. Hopefully, this classic advice is being followed.
“Diversification strategies are essential, time-tested tools for every nest egg.”
The main goal of investment diversification is to contain the damages of market volatility from being inflicted on the nest egg. The importance of this is fundamental and always in fashion. I highlight some key observations on portfolio diversification:
- Investment portfolios suffer from inadequate diversification.
- Mutual funds we own often have the same, or similar, stocks.
- Investors are not aware that they lack diversification.
Diversification strategies are essential, time-tested tools for every nest egg. They improve your chances of achieving better consistency of long-term returns. It’s a focus for every investor to prioritize.
Basic diversification involves spreading your risks across different sectors of the economy. All within the asset allocation targets set by your investment plan of action. Make sure that you are comfortable with the approach so that you don’t have to dwell on regrets. Portfolios I review range from too concentrated to well over diversified.
Overall, diversification is a necessary safeguard. You don’t want problems arising in any asset class to ruin your well-designed portfolio. Especially the one that delivers the family’s retirement cash flow.
Develop sound habits
Diversification increases the odds of you being right more often than wrong. When some selections are suffering, others can step up and help cushion the rest of the portfolio.
Make it your habit to keep your nest egg from slipping off the rails. I summarize my top ways to achieve necessary portfolio diversification:
- Asset Classes: Choosing different asset classes for the game plan is a sensible and prudent step. Stocks, bonds, cash, commodities and real estate are common picks.
- Economic Regions: Portfolios may include selections from Canada and other regions around the world. Like the USA, Europe, Far East and emerging countries.
- Time to Maturity: A portion of the portfolio could have a range of investment maturities. From as short as 30 days to as long as 30 years.
- Foreign Currencies: Investment selections can be purchased in currencies other than Canadian funds. Such as US dollars, the Euro or hedged to our Loonie.
- Investment Quality: High investment quality trumps reaching out for questionable yield. Trading quality for higher yields increases the potential to incur large losses.
Portfolios ought to contain a variety of investments that don’t all move in unison. However, seasoned investors know full well that is not always possible.
My table below is far from scientific. Look upon it as a broad brush view of portfolios that own Exchange Traded Funds (ETFs) and/or mutual funds as their primary investments in equities. Each investment selection is referenced as a “basket.” I divide the diversification landscape into three ballparks.
Here is my brief assessment of such portfolios:
|Probable Diversification||Investment Baskets Owned|
|Low/Insufficient||1 to 7|
|Medium/Balanced||8 to 15|
|High/Overdiversified||16 and over|
Setting portfolio diversification suitable for your needs is not an isolated event. It is best dealt with alongside other portfolio cornerstones such as risk tolerance, investor profile, time horizon, target asset mix and rebalancing. That is a full plate of activities for any investor.
Start by reviewing your comfort with the current portfolio. Diversification should be front and centre in managing your nest egg. It is not a precise process; therefore, adopt investing strategies that reduce portfolio risks and aim for more consistent results. I find it helpful to ascertain how much financial damage the client can endure within the present asset mix.
Staying on the rails is my preferred approach. That makes for happier investing in the long run.