Your Portfolio and Diversification
Diversification should be an important part of everyone’s strategy when it comes to investing, but it can be easy to either over or under diversify. Many people think they’re diversified, but when you dig deeper on any given portfolio, we find that’s often not the case.
You want to choose a variety of assets – stocks, bonds, cash, and others – but you also want to choose ones whose returns haven’t all historically moved in the same direction, and, ideally, assets whose returns typically move in opposite directions to help your portfolio hold up better in down markets.
That way, even if a portion of your portfolio is declining, the rest of your portfolio, hopefully, is growing, and you can potentially offset some of the impact of poor performance on your overall portfolio.
Another important aspect of building a well-diversified portfolio is that you try to stay diversified within each type of investment. In terms of your individual stock holdings, beware of overconcentration in a single stock. We usually advise our clients that a single security shouldn’t account for more than 5% of your stock portfolio, unless it’s with the company you work for, and even then, you should limit it to 25% if you can. It’s also smart to diversify across stock holdings by market capitalization (including small, medium, and large caps), sector, and geography.
Another important consideration is stock overlap or duplication between funds. Many people select what they think are very different funds, when in fact they may not be. These 3 funds are fairly diversified on their own. But if you were dig a bit deeper on all three of these, you might notice that the first 5-6 of the top 10 stocks within each are the same.
Another key issue to maintain diversification is rebalancing. Rebalancing is the mechanism to replenish diversification. Many people forget that diversification isn’t a one-time task. Without rebalancing, a portfolio tends to become more concentrated in the assets that have performed well. The benefits of the original plan start to erode. With the relative strength in equities over bonds, US equities over international stocks, and growth stocks over value stocks in recent years it’s entirely possible portfolios have become less diversified and need to be adjusted.
When you do rebalance, it’s important to take advantage of tactical tilts based on market and macroeconomic conditions. This is where your financial professional should play an important role. We have rebalanced and reallocated portfolios 3 times this year to help protect them from possible inflation. This will also help them to take advantage of other trends and forces in the markets right now, like the shift from growth to value we have been seeing since the beginning of the year.
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