Adapt and diversify your portfolio

How can you manage volatility with proper diversification? What is diversification? I believe that most investors, most advisers, most money managers do not truly understand how diversification is supposed to work. It’s very, very important in these types of economic times with tremendous volatility, especially as you age to have your investments to be more stable.

Diversification really means that you have a whole bunch of stuff in your portfolio that doesn’t move together. So if one holding zigs, another zags. In a short period of time, anything can happen, but over time, you have things moving differently. There’s really four or five economic conditions we can see from boom to bust and everything in between, but I believe nobody really knows when those are going to happen. In any of those types of economic conditions, there’s going to be some sort of asset class or classes that are performing pretty well. It may mean it’s just holding its own but it’s not losing a lot of money.

When those things happen, we better be sure we own some of those hedges. Think of them as hedges in a portfolio. We better be sure we own those things, so they can help buffer the blow. When we’re younger we don’t need as much of that. Whereas when we get older, we want more stability investments. We need more of that.

I have found since the Great Recession that our markets are being driven my much more macro-economic events than they are actual market fundamentals. This current market is a great example. There’s a disruption between our current markets here in the U.S. and what’s really going on economically and it’s because of macro-economics around the world with China and oil, but the way you manage this is by having true diversification. Understanding that and also asking yourself how much do you want to stabilize your returns, which means you make less in a good market and lose less in a bad market.

I’m talking about the risk portion of your portfolio. The safe portion doesn’t lose anything. So we manage risk by having some money safe where you have guarantees of principle. You have to look at who’s backing the guarantee but you have safe money. It’s not losing. The risk money you’re not just betting money on the stock market. I’ll tell you this a 60/40 mix of stocks and U.S. bonds, which is what most people do, you’re betting on the stock market in that portfolio. That portfolio overwhelming moves with the market, maybe not quite as fast but it moves up and down, highly correlated with the market.

Most people I talk to in retirement find that’s not enough diversification. You need other holdings that zig and zag, so be sure that you’ve identified your risk appetite and understand how true diversification really works.