Monday, May 17, 2010

Why Stock Diversification Doesn’t Work

Why Stock Diversification Doesn’t Work

In the aftermath of the 2008 stock market meltdown, many investors – perhaps yourself included – have rightfully begun to seriously question the validity of the strategies they have been pursuing with their nest-eggs, courtesy of the advice they’ve been receiving from their financial advisors, books, magazines, websites, TV, and radio shows.

In their usual attempt to calm frayed nerves, so-called investment experts claim that investors could have somehow magically escaped the beating their portfolios received if they had “diversified” among different classes of stocks and bonds, both domestically and across the globe.

What About Those Investors Who Did Exactly That and Still Suffered Significant Losses?

My common-sense view is that the only viable solution is to not invest your serious cash (like your retirement money) directly in the market, period! None of our clients had to change anything of their strategies because their portfolios did not suffer any losses. In fact, they actually EARNED money during the exact same period that other investors could barely muster the courage to open their investment account statements.

One thing I know for sure – and that every rational investor and advisor also knows, or should know – is that stocks fluctuate, and no one – I repeat, no one – knows exactly when the market will turn south. The sad truth, though, is that most peoples’ portfolios reflect the exact opposite position.

Three Baffling FACTS

First, those same advisors/experts advised, encouraged, and designed the “diversified” portfolios their clients owned just before the bottom fell out. Then, after the disaster which no one saw coming, they claim that if the investors had better/differently/more smartly diversified, their portfolios would not have been devastated. No wonder they call it Monday-morning quarterbacking – who can’t assess what went wrong in hindsight?

Second, in 2008 the S&P 500 lost 38.5 percent, the Dow dropped by 33.8 percent, and the NASDAQ fell by 40.5 percent. But the majority of the investors whose retirement portfolios were devastated had already diversified, so why did they still suffer such huge losses? It is extremely important for you to understand that every major market in the world dropped significantly at the same time. Actually, European and Asian stocks did even worse than U.S. stocks. So what does that say about those gurus who insist that investors should have diversified across multiple geographies in order to avoid the beating their nest eggs received?

Finally, the other critically important thing that 2008 taught – or should have taught – investors is that bonds are not safe haven either, because the largest bond fund on the planet lost about 36 percent.

Diversification could reduce the impact of your loss in the instance that you owned Enron stock in a proportion small enough that when it collapsed, those losses were overshadowed by gains from other well-performing stocks in your portfolio. But why would you take the chance of ruining your retirement by investing directly in the market, when it is completely unnecessary?

At the end of the day, it’s as plain and simple as this: You can diversify your stock portfolio all you want to, but you’ll also have to pray that the market doesn’t experience any massive losses like it did in 2008. The harsh reality is that millions of Americans lost significant portions of the retirement savings it took them years to build. Meanwhile, the stock market continues to fluctuate as you read this, and will continue to do so. Don’t you find this platitude of “just diversify, and you’ll do great” offensive? I do.
Call Laser Financial at 301.949.4449 or visit our Web site to set up your personal consultation with a strategist who can explain why diversity may or may not be the best option for you at this time.

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