Every evening, it seems, we get news of the stock market hitting another record high. People are making money. They’re happy. All seems well.
Time to interject some caution. I have seen this story before — more than once, actually. My advice remains the same:
You’ve got to diversify.
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Most people aren’t properly diversified. Yes, they are making money. Yes, their investments are growing, sometimes at a terrific rate.
You may think you’re diversified
Just because you own multiple mutual funds, that’s not a guarantee of diversification. The assets can be correlated. They all react in the same way.
Typically, someone might have an IRA they’re managing on their own and it has a lot of blue-chip stocks that are performing well. They might have a 401(k) from their work that includes four or five mutual funds, mostly growth-oriented. Different investments, yes. But they are invested with the same market risk, so they’re not really diversified.
If the market is doing well and the economy seems to be improving, everything goes up. What’s wrong with that? Simple. What happens when the market isn’t doing well?
If the market starts to struggle, then EVERYTHING in the portfolio is probably going to go down. Then you have a problem on your hands.
Don’t make the same old mistakes
With the growth stocks performing exceptionally well, I think that has led to some complacency — almost a false sense of security. You can almost see a repeat of the mistakes we witnessed in 1999 and obviously 2007, prior to the two most recent bear markets we have experienced. And that’s a big concern.
It’s a dangerous mistake for our clientele, most of whom are retirees or people who plan to be retired in five or 10 years.
When the market is up and everything is performing well, even though someone is getting closer to retirement, they really don’t adjust their portfolio. It’s very difficult for people to sell a winner, lock in profits or take some risk off the table, especially when everything marches higher.
People will say, “Oh, if the market goes down or things get a little rough, we’ll make some adjustments.” It’s almost like they’re claiming to have a crystal ball. I heard the same things in 1999 and 2007, and I don’t recall anyone who actually made those adjustments.
So how do you diversify your portfolio? This will sound counterintuitive. You want to invest in positions that aren’t necessarily losing but may be lagging behind some of your other positions. Again, it might sound strange, but let me explain.
If everything in your portfolio is way up right now, sure, it feels good. But it means everything is correlated. As soon as the market turns around and we get bad economic reports, everything in your portfolio is likely to go down. Without true diversification, you can’t weather the bad times.
Remember the cautionary tale of 2007
And let’s not kid ourselves. History tells us there will be some bad times.
I remember meeting with people in 2007, and I expressed concern about their lack of diversification. They didn’t listen. When the market went down, I got story after story about people who thought they were six months from retirement. Some of them are probably still working today.
Some people lost so much and they were angry with whomever they had their money with, but did they follow the advice? Maybe they got a second opinion and still didn’t listen. They just didn’t want to hear it.
When everything is consistently going up, people want to ride that wave. We also see people who believe they can manage money on their own. When the market constantly goes up and it’s easy to make money, people naturally think they can do just as good of a job as their adviser.
In a good market, that might be true.
But I believe the professionals in our business separate themselves from the amateurs when things aren’t going well. When the market isn’t growing at a rapid rate, that’s when an adviser can provide the guidance, expertise and discipline needed in rough times.
4 tips for proper diversification
If you need to diversify, if you’re looking for an adviser or someone to provide a second opinion, here are my recommendations:
Understand true diversification. If there’s an underperforming position in your portfolio, don’t panic. Know that it could be there strictly for diversification. When the tide turns, it will act as a hedge and counteract a falling market.
Educate yourself. Know how commodities, foreign investments and fixed-income investments figure into a properly diversified portfolio. We’ve always been told not to put all our eggs in one basket, right? Similarly, you need different buckets of money, not things that look the same.
Find an adviser right for you. Different people need different styles. If you’re a do-it-yourself type of investor, you won’t need the same level of guidance as someone who just looks at their statement a couple of times a year. Regardless, find someone who aligns with your values and doesn’t try to be all things to all people.
Follow success. I believe that success leaves clues. Every adviser will say they can make you happy and get you the desired returns. But who are their referrals? Are CPAs, estate-planning attorneys and other professionals recommending them? Is the adviser a published author? Does he or she write articles in financial magazines or have a weekly radio show? Everyone claims to be an expert. But the true experts usually have some clues out there you can investigate. They can get you on the right path to diversification.
Joey Johnston contributed to this article.
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