Why Is Diversification Important for Asset Management?
Topics: Risk Reduction, Financial Planning, Asset Allocation
If you haven’t noticed the fallout in the stock market from Coronavirus concerns – and more recently global oil supply/demand imbalance concerns – good for you! I certainly appreciate the renewed interest in my financial services business! It is as important as ever to make sure you have a Financial Plan in place to deal with these challenging, even unprecedented times. That’s the whole reason I’m writing this post today and why I continue to preach the importance of diversification within your portfolio and how that will ultimately lead to more effective Asset Management.
As I noted in this Facebook post from January there were several signals about the market being overvalued. At that point I did reduce risk – less small cap and emerging markets, while increasing my cash position and exposure to dividend payers – nothing drastic. None of my moves are ever drastic. Why not go to 100% cash? Well we don’t know when the market will turn over. Just like we don’t know when to buy back in – a question I’ve gotten several times in the last few weeks. However, following a well-organized plan of rebalancing your diversified portfolio in times of volatility can help reduce irrational and emotional decision-making.
3 topics on the importance of Diversification in Asset Management:
- Risk Reduction
- Financial Planning
- Asset Allocation
So in this crazy market how do you win? Save money. Save it often and regularly. Save with a plan in mind. Know where your discretionary dollars are going so you eliminate wasteful spending and try to take emotion out of investing. I can help with all those things!
Before we continue on the importance of Diversification:
- Questions on retirement or other financial goals? Email me: email@example.com.
- Do you need a CFO for your Household? We can help. Check out our Cash Flow Management service, a service which I believe can pay for itself!
- Curious about your net worth or ready to start your Financial Plan? You can create your own Right Capital login.
On a personal note
I haven’t always employed a diversified portfolio. At my first job, I was 100% invested in the stock of the company I worked for - Exxon Mobil (ticker – XOM)! Yes, it’s a good company – the biggest in the world until it was overtaken by tech – but 100% of my portfolio in a single stock!?! Of the company I worked for!?! A co-worker at the time mentioned his dad had invested in XOM his entire career while working there and had a 7-figure retirement fund. That sounds awesome – sign me up! I’ve since heard other stories like that – working for the same bank all your life and simply buying their shares in your 401K. Well the financial crisis 10 years ago may have both slashed your net worth and your job outlook.
It was painful to sell my XOM stock and diversify. The stock had done well, and I was emotionally connected to it, but ultimately it was the right decision. Had I remained invested this way my net worth would have been reduced by 20% in the last week! That’s not a risk I can live with at this point in my life. If you want to own your own company stock or any other stock with emotional value, I encourage you to make it 5% or at most 10% of your portfolio. The idea is to leave the emotion out of investing.
So onto why diversification is important to Asset Management:
Diversification is part of risk reduction
The reduction of risk is by far the most important reason to diversify your asset base. The last three weeks have been filled with headlines that continue to whipsaw markets. The economic impact of shutting down entire countries is not yet understood but markets are always working to price in these future events. Uncertainty creates volatility. Our government continues to seek ways to slow the damage – buying bonds, providing liquidity, slashing lending rates, helping small business and taxpayers with relief plans, all while trying to manage the panic related to the Coronovirus.
In my blog post for small business owners, I noted the importance of retirement planning with the driver being diversification. I recommend small-business owners have a diversified asset portfolio (preferably a 401K plan, or Solo 401K for individuals), not simply assets focused on the business they operate. A diversified 401K plan serves that purpose and provides employee incentives.
Furthermore on the need for diversification, the turmoil in the last 10 days or so within my old world, Oil and Gas, saw incredible value destruction, as two of the three largest global oil producers, Saudi Arabia and Russia, couldn’t come to terms for a supply reduction, so now a pricing war has pushed WTI crude oil to about $32, down more than 20% in a single day last week. U.S. producers are at the mercy of a commodity, where the price is now evidently under the control of people that can’t get along. If you are heavily invested in AND working in Oil and Gas, you may be concerned about your wealth and your career. As much as Oil and Gas was part of my life (and previously my portfolio!), its only allocated 5% of my portfolio.
Diversification is part of financial planning
Have I mentioned I do financial planning? And that its important? LOL! But, with a plan in place, you would be diversified. Plus, in rebalancing to fit your plan, you are forced to buy low and sell high, removing emotions from the equation. Furthermore, it’s not a timing game, it’s a long-term commitment. Our Financial Planning services can help determine your net worth, your goals and the probability you have to achieve those goals. Quite simply, the formula for retirement is to live below your means to create the opportunity for an above-average savings rate, and then invest those savings regularly for the long-term in diversified assets. This regular, routine investing, though boring, also insures you are buying more shares when they are cheap and fewer when they are more expensive (dollar cost averaging).
Diversification is part of asset allocation
Hand in hand with financial planning is your asset allocation, or how your assets are invested based on your goals, risk tolerance, time horizon and other investment objectives. What we’ve seen in the market recently is riskier assets underperforming. I see it as I look at rebalancing client portfolios – I need to buy the underperformers and trim outperformers back into proportion. With my cash position becoming a larger proportion of my portfolio, I have those excess funds (as a % of assets) to put back into the market. It’s not about trying to time the market but rebalancing back to a planned asset allocation.
We can’t consistently know when the market is going to change, but paying attention to signals and adjusting your portfolio, can help us be more prepared. Having a plan in place can outline our strategy to make sure fear and panic don’t take over. The adjustments don’t even need to necessarily be frequently. In fact, trading costs can add up for frequent traders. But bigger swings in the market can often be a time to rebalance, forcing you to sell shares that have outperformed and buy those that have lagged. And of course, diversification must be part of the overall investment strategy.
Please check out my blog posts for more financial topics:
If you or someone you know has any financial-related questions, I would love to have a conversation, so please feel free to reach out: firstname.lastname@example.org.
And stay tuned for additional blog posts on retirement savings and other topics.
Best wishes on your financial path!
This post was created by Matt Beeby, the Founder of MHB Advisory Services. Matt has been working in Financial Services and investing in real estate since 2005, though his investment experience spans nearly two decades. He is a Christ follower, active in both his church and his neighborhood association. Matt enjoys sports and family time. Read more about Matt on his website bio.
- Information contained in this document is for informational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any product or security.
- This information is believed to be accurate and should not be considered tax or legal advice.
- Please consult tax or legal professionals for such advice and be sure to consult with a qualified financial advisor and/or tax professional before implementing any strategy discussed.
- Investments involve risk and are not guaranteed to appreciate, and past performance is not indicative of future results.