One of the first things you hear when you start learning about finances is the word diversification. It is one of the golden rules of investing. But why? It’s all about risk. Let me tell you a story.
Let’s say after a couple of decades in the workforce you finally get an opportunity to work at “America’s Most Innovative Company.” At least, that’s what Fortune magazine has been calling it for 6 years. You’re thrilled at the opportunity and pour your heart and soul into your work. As an employee benefit, they offer a retirement plan and you even have the opportunity to invest that money into your own company’s stock. It would be crazy not to invest in the country’s most innovative company! By age 50, your accounts have surpassed a million dollars and you’re starting to plan an early retirement.
Does that sound like a dream to you? It did to many. Unfortunately, though, it turned out to be a nightmare. You see, that company was so innovative that they got overly creative with their accounting as well. Its name was Enron. You’ve surely heard of Enron’s accounting scandal and how many of their employees lost their entire life savings and their jobs at the same time.
That is the opposite of diversification.
Different Kinds Of Diversification
The sad story of Enron’s employees was a wake-up call for many, and America learned well the dangers of investing everything in one single company. When most people think of diversification, they think of investing in a broad array of stocks, in companies of different sizes and in different industries.
That is one kind of diversification, and it does a good job of reducing the unsystematic risk of a stock portfolio. Unsystematic risk is company-specific risk. If you invest in a bunch of different companies, it won’t affect you very much when one of them fails.
It does nothing for systematic risk, though. That’s the risk associated with the stock market as a whole. The stock market moves in cycles, so it goes up and down with regularity. If you have everything invested in the stock market, then when it goes down, you’re going down with it.
Asset Classes To Consider Investing In
For most people, it’s good to invest in stocks. However, it’s even better to invest in more than just stocks. If you invest across various asset classes, then when you lose money in the stock market, you may still be making money elsewhere. For that to happen, you have to invest in uncorrelated asset classes. Uncorrelated simply means that they aren’t so interrelated that they move in the same direction.
Bonds are another popular investment option because they have a very low correlation with stocks. Sometimes they move in the same direction, sometimes they don’t. Their performance is not tied to each other and therefore provides better diversification. They also are less volatile, so they don’t take investors on as much of an emotional roller coaster ride.
Other fixed-interest investments with a low correlation to the stock market are T-bills and certificates of deposit (CDs). These are often used to anchor a portfolio and provide protection of capital.
Real estate is another good investment with a low correlation to the stock market. Real estate is popular because it is a very tangible asset and many people participate in the real estate market through owning their own homes.
Many investors shy away from real estate, though, because it costs a lot of money to purchase an entire home or they don’t want to be landlords. Those can both be major barriers to entry into the real estate market. Yet, you don’t have to purchase property directly to invest in real estate.
You can invest in a real estate investment trust (REIT). REITs sell like stocks on exchanges and invest directly in properties or mortgages. Through a REIT, you can reap the high yields of investing in real estate but have higher liquidity than you would if you owned property directly.
How We Can Help
As you can see, it isn’t enough to simply have a diversified stock portfolio. You need to diversify your portfolio beyond just stocks if you want to reduce volatility and improve overall performance. Lucky for you, there are a number of uncorrelated asset classes available to you.
How is your current portfolio? Is it well diversified? You may not be at risk of experiencing what the Enron employees did, but could you still have more risk than necessary? The best way to find out and build an investment portfolio that will limit your risk exposure and allow you to achieve your goals is to work with an experienced financial advisor. For a free portfolio review, call us at (626) 529-8347 or email Ricky directly at firstname.lastname@example.org.
About Haydel, Biel & Associates
Haydel, Biel & Associates is an independent financial advisory firm serving individuals and families near Pasadena, California. The firm was founded in 2004 by Chris Haydel and Ricky Biel with a desire to provide unbiased, client-centered, community-based financial advice. Together, they have built a practice that has grown into a family of caring, smart professionals committed to blending proven investment methodologies with creative financial technologies that make it easier than ever to accomplish your goals. They strive to keep things simple and fun to give their clients peace of mind and alleviate financial stress. HBA Wealth takes care of their clients’ needs first and foremost and goes the extra mile to make their clients’ finances grow. To meet and see how the HBA Wealth team may be able to help, contact them today at (626) 529-8347 or email Ricky directly at email@example.com.
The commentary on this blog/website reflects the personal opinions, viewpoints and analyses of the Haydel Biel & Associates employees providing such comments, and should not be regarded as a description of advisory services provided by Haydel Biel & Associates or performance returns of any Haydel Biel & Associates Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Haydel Biel & Associates manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.