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Why Is Diversification Important for Asset Management?

Investing Insights

Why Is Diversification Important for Asset Management? 

Topics: Risk Reduction, Financial Planning, Asset Allocation

The initial writing of this post was nearly 5 years ago as the stock market was struggling with uncertainty around Coronavirus concerns. Since that time, the market has ebbed and flowed, most recently driven by expectations for inflation and interest rates - though the market gyrations of the last week have been a function of what investors believe a new POTUS can do for our government. Regardless, it is as important as ever to make sure you have a Financial Plan in place to deal with these challenging 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.

Flash back to almost five years ago, as I noted in this Facebook post from January 2020 there were several signals about the market being overvalued at that time. Interestingly enough the market cratered as COVID uncertainty played out, but quickly rebounded and ended the year more than 10% higher! The market turned back to being EVEN MORE overvalued in 2021 (according to Morningstar) before a correction began in early 2022 that basically left asset values flat for two years. While the market has continued to set new record highs throughout 2024, it remains noteworthy that the recent run-up in the market has now put us at a similar level of overvaluation we saw nearly three years ago.

What's the point? Market timing doesn't work, so don't try it. Your better move is to save early and often. 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:

  1. Risk Reduction
  2. Financial Planning
  3. Asset Allocation

So in this volatile 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: matt@mhb-advisory.com.
  • Do you need a CFO for your Household? We can help. Check out our Our Services.
  • 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 in 2008 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 subject to substantially more volatility. 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. Uncertainty creates volatility. Our government printed money that caused rampant inflation that has taken several years to work through. Were you invested in assets that held up during inflation? Dividend and large-cap stocks, real estate, commodities? Now of course the investment du jour is bitcoin, or really any cryptocurrency. Has the value of these "assets" really increased 50% or more in the last month? Or is there a massive amount of speculation going on? Sure, it would be great to have at least part of your portfolio in crypto, but there is way too much risk to in an unproven asset class - better to maintain a diversified portfolio to help with risk reduction.

Furthermore, 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.

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 of achieving 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. Anytime you experience substantial volatility in the market, I see this as an opportunity to rebalance 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 you 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:

Why Should I Use a Financial Advisor for Asset Management?

How Do I Get Out of Credit Card Debt and Start a Budget?

Are Maximum 401K Contributions Best for My Asset Management Strategy?

Should I Pay Off My Mortgage Early?

How Can Effective Asset Management Help Me Reach Financial Independence?

How Much Money Do I Need to Save for Retirement?

How Much Should I Save for College?

Why Should a Small Business Owner Have a 401K Plan and What Are the Best Savings Options?

What Financial Advisor Qualities Can Enhance Overall Asset Management?

Best (Most Read) MHB Advisory Blogs of 2019!

Why is the Solo 401K the Best Asset Management Tool for Real Estate Agents?

What Should I Do with My Old 401K When I Change Jobs?


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: matt@mhb-advisory.com.

And stay tuned for additional blog posts on retirement savings and other topics.

Best wishes on your financial path!

Matt

 

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.

 

  • Disclosures:
  • 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.
  • Additional information including our privacy policy and Form ADV are available on request or can be found on our website: mhb-advisory.com.

 

Sources:

https://www.morningstar.com/markets/fair-value

https://finance.yahoo.com/quote/XOM?p=XOM&.tsrc=fin-srch

https://www.investopedia.com/investing/worlds-top-oil-producers/

https://www.cnbc.com/quotes/?symbol=@CL.1

Photos: https://unsplash.com