Opinion: This time-tested strategy takes investing risk head-on
From: marketwatch.com
In 2015, a diversified investment portfolio didn’t really protect you from the market’s gut-wrenching volatility.
There’s a good chance that 2016 will be a repeat, this time with bond funds suffering through a rising-rate environment, stocks struggling against volatility, emerging and international markets offering little help, and cash and money markets offering only near-zero returns.
As a result, the new year again has investors wondering whether diversification — spreading your money into various asset types so that you take on many risks to leave yourself, theoretically, with something always doing well — is still worth the effort.
That’s especially so in the face of “event-driven investing” and “tactical asset allocation” — two increasingly popular investment categories that boil down to focusing on what’s working or poised to emerge.
Diversification is such bedrock, cornerstone investment policy for the average guy that arguing against it is like saying something bad about apple pie.
For long-term buy-and-hold investors, putting money in various asset classes — domestic and international, large and small companies, bonds, commodities, cash and more — tends to instill the peace of mind needed to stay the course through all conditions.
Over time, diversification tends to deliver a smooth ride, even if it doesn’t necessarily “work” during all those times.
2015 was one of the times when diversification appears to have let investors down.
Dan Wiener, editor of the Independent Adviser for Vanguard Investors, noted recently that the average Vanguard investor lost money in 2015, due largely to losses in emerging markets and international stocks outweighing small gains for domestic stocks and bonds.
He noted that the Vanguard Investor Index — an asset-weighted measure of the performance of all Vanguard funds and annuities — was off in 2015, making it the first time since 2008 that the average Vanguard investor was down. It was just the fifth decline in the last quarter-century.
While those numbers show the struggle of diversification in 2015, that long-term picture shows why investors shouldn’t be spooked out of the practice.
“It’s never the year that diversification works,” said Jonathan Clements, a long-time personal-finance writer and author of “Money Guide 2016.” “If you’re properly diversified, you will always own the worst-performing part of the market. That is the nature of diversification.”
In an appearance on “MoneyLife with Chuck Jaffe,” Clements noted that the bad news of owning the market’s losers in a broadly diversified portfolio is balanced out by the good news of owning the market’s winners.
“The only way to guarantee you’re going to capture the market’s rise over the long haul is to be diversified,” he said. “If you are not diversified and you are betting heavily on a few sectors of the market, it’s entirely possible that you could suffer lousy returns over a lifetime of investing.”
Investors ready to give up on diversification are surrendering that ability to capture the tendency of the market to rise over time, replacing it with a strategy that assumes they will always be able to identify what’s working. They are avoiding the bad news, hoping to generate their own good news by owning what has been on the rise.
That’s a great strategy — except most investors simply can’t do it.
Countless studies show that investors tend to buy into a rising market only after much of the heat has played out, leaving them vulnerable when the market turns. Effectively, they buy high and sell low, whereas spreading a money into a diversified portfolio — and using additional deposits to keep allocations in line with the plan — tends to result in buying low, knowing that the strategy will eventually pay off.
Moreover, investors who follow a diversified plan tend to avoid overreacting to fear and greed.
While playing to those emotions might look like a winning strategy in any given year, sticking with a long-term methodology tends to be the victor for investors who stay with it.
Market veteran Bill Nasgovitz of the Heartland Funds noted that investors tend to be best-served by sticking with time-tested methods, rather than changing their tune just because of the market’s action for a year — or even a decade.
“Whatever your methodology,” Nasgovitz said, “hopefully it helps you handle and weather the extremes of fear and greed, so you don’t get excited at the top when everybody else is buying like crazy and, visa versa, you don’t get too depressed and sell everything out — and we all know people who have, reacting to the past and perhaps making the bottom, because they are fed up and fearful the world is coming to an end.”
