Most Popular
1. Banking Crisis is Stocks Bull Market Buying Opportunity - Nadeem_Walayat
2.The Crypto Signal for the Precious Metals Market - P_Radomski_CFA
3. One Possible Outcome to a New World Order - Raymond_Matison
4.Nvidia Blow Off Top - Flying High like the Phoenix too Close to the Sun - Nadeem_Walayat
5. Apple AAPL Stock Trend and Earnings Analysis - Nadeem_Walayat
6.AI, Stocks, and Gold Stocks – Connected After All - P_Radomski_CFA
7.Stock Market CHEAT SHEET - - Nadeem_Walayat
8.US Debt Ceiling Crisis Smoke and Mirrors Circus - Nadeem_Walayat
9.Silver Price May Explode - Avi_Gilburt
10.More US Banks Could Collapse -- A Lot More- EWI
Last 7 days
Stock Market Volatility (VIX) - 25th Mar 24
Stock Market Investor Sentiment - 25th Mar 24
The Federal Reserve Didn't Do Anything But It Had Plenty to Say - 25th Mar 24
Stock Market Breadth - 24th Mar 24
Stock Market Margin Debt Indicator - 24th Mar 24
It’s Easy to Scream Stocks Bubble! - 24th Mar 24
Stocks: What to Make of All This Insider Selling- 24th Mar 24
Money Supply Continues To Fall, Economy Worsens – Investors Don’t Care - 24th Mar 24
Get an Edge in the Crypto Market with Order Flow - 24th Mar 24
US Presidential Election Cycle and Recessions - 18th Mar 24
US Recession Already Happened in 2022! - 18th Mar 24
AI can now remember everything you say - 18th Mar 24
Bitcoin Crypto Mania 2024 - MicroStrategy MSTR Blow off Top! - 14th Mar 24
Bitcoin Gravy Train Trend Forecast 2024 - 11th Mar 24
Gold and the Long-Term Inflation Cycle - 11th Mar 24
Fed’s Next Intertest Rate Move might not align with popular consensus - 11th Mar 24
Two Reasons The Fed Manipulates Interest Rates - 11th Mar 24
US Dollar Trend 2024 - 9th Mar 2024
The Bond Trade and Interest Rates - 9th Mar 2024
Investors Don’t Believe the Gold Rally, Still Prefer General Stocks - 9th Mar 2024
Paper Gold Vs. Real Gold: It's Important to Know the Difference - 9th Mar 2024
Stocks: What This "Record Extreme" Indicator May Be Signaling - 9th Mar 2024
My 3 Favorite Trade Setups - Elliott Wave Course - 9th Mar 2024
Bitcoin Crypto Bubble Mania! - 4th Mar 2024
US Interest Rates - When WIll the Fed Pivot - 1st Mar 2024
S&P Stock Market Real Earnings Yield - 29th Feb 2024
US Unemployment is a Fake Statistic - 29th Feb 2024
U.S. financial market’s “Weimar phase” impact to your fiat and digital assets - 29th Feb 2024
What a Breakdown in Silver Mining Stocks! What an Opportunity! - 29th Feb 2024
Why AI will Soon become SA - Synthetic Intelligence - The Machine Learning Megatrend - 29th Feb 2024
Keep Calm and Carry on Buying Quantum AI Tech Stocks - 19th Feb 24

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Is your portfolio properly diversified ?

InvestorEducation / Investing Mar 22, 2007 - 10:45 PM GMT

By: Hans_Wagner

InvestorEducation

If you have ever watch Jim Cramer and his segment “Are you diversified?” then you probably have some idea what lack of diversification means. The idea is to Beat the Market investors should maintain a diversified portfolio. The problem is that many investors think they are diversified and therefore protected from the market's risks (at least somewhat). Well, this might not be accurate. 

Gary Marks a successful money manager has written a book that is causing some problems with some brokerage firms. The book Rocking Wall Street: Four Powerful Strategies That will Shake Up the Way You Invest, Build Your Wealth And Give You Your Life Back received a highly complimentary statement from a senior portfolio manager at a major brokerage firm that lead the firm's compliance department to issue a written warning to Mr. Marks not to use his quote to promote the book. 


This book offers ideas to help develop a philosophy of investing; explaining specific strategies and techniques to create your own diversified portfolios that balance the risks and rewards of the market. For example, what if the current diversification models were considered too risky and ineffective? 

When hedging your investments one of the most common assumptions made, yet not usually mentioned, is all the investments are based on the upward trends in the markets or stocks. When this happens your diversification actually decreases. The reason is that all you assets are counting on the up trends and/or well being of the global markets.

When bear markets happen, they usually make the assumption they will have the staying power to wait out the losses they experience during a bear market. But what if the bear market lasts years, or maybe even a decade? During the twentieth century the average secular bear market in the U.S. was 17 years. During that time investors can lose fortunes for themselves and their families. Not many of us have the financial or psychological strength to sustain ourselves during these down cycles.

Most investors remember the downturn that started in 2000 and went through 2002. Their 401(k) accounts, IRAs and personal portfolios lost 20 to 50 percent of assets value. Remember if you lose 50% of the value of a portfolio, then the portfolio must now double (grow 100%) just to get back to where you were. That can is hard to accomplish and takes time.

These investors felt they were diversified having spread their portfolio among stocks from different sectors as well as holding bonds and some cash. Yet they still experienced significant losses. The list below provides a sampling of what happened too many of the indexes and asset classes traditionally used to diversify portfolios from their historic highs in 1999 or 2000 to the end of 2002.

Index Performance*
Russell Small Cap Index -36%
Dow Jones Industrial Average -38%
S&P 500 -49%
NASDAQ -78%
Gold Index -64%
Biotech Index -66%
European Index -63%
Asia Index -58%
Brazil -58%
Argentina -70%
China -52%
India -58%
Japan -61%
*highs 1999, 2000 to lows 2002

Ok, what if an investor had the broadly diversified 60/40 stock to bond portfolio during this down turn? For the 60% stock portfolio let's assume this investor held the S&P 500. For the 40% bonds lets use the Lehman Aggregate Bond Index from 2000-2002. Holding these two indexes would have produced a 16% loss during this time frame. Not a very good return for a conservative portfolio that is properly diversified. Just imagine the loss if this investor had been more diversified in NASDAQ and foreign stock indexes.

This analysis is telling us that traditional ways of diversification won't save you. Essentially true diversification must include more investment choices than just stocks and bonds. It includes investments that offer alternative ways to generate positive returns while reducing risk, such as home ownership, savings plans, etc.

Just to remind everyone, the one day drop in the market on February 27, 2007 that has received so much press due to China's 9% market decline generated the following losses in the indexes:

Index Performance February 27, 2007
Russell Small Cap Index -3.77%
Dow Jones Industrial Average -3.29%
S&P 500 -3.47%
NASDAQ -3.86%
Gold Index -7.16%
Biotech Index -3.69%
European Index -4.11%
China -9%
Brazil -6.63%
Argentina -7.49%
India -4.01%
Japan -2.85%

 

Once again diversification may have not provided the lower risk strategy as promised. I will have more on this topic throughout this year.

 

By Hans Wagner
tradingonlinemarkets.com

My Name is Hans Wagner and as a long time investor, I was fortunate to retire at 55. I believe you can employ simple investment principles to find and evaluate companies before committing one's hard earned money. Recently, after my children and their friends graduated from college, I found my self helping them to learn about the stock market and investing in stocks. As a result I created a website that provides a growing set of information on many investing topics along with sample portfolios that consistently beat the market at http://www.tradingonlinemarkets.com/


© 2005-2022 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in