When It Comes to Investing, Diversification Is Not All the Same
When the stock market took a dive in 2008, plenty of people thought their portfolios were well protected against anything too dire. After all, they had carefully made sure they had a diversified lineup of investments, as nearly everyone recommended. No putting all the eggs in one basket for this savvy group.
Yet, after the market had crashed and the metaphorical smoke cleared, they realized their portfolios had lost close to 40% of their value (for some individuals, maybe more). That left some investors confused. How could I lose this much money, they wondered, if my portfolio was truly diversified?
Sadly, here's the reason: Not all diversification is the same.
With traditional investing, people often will put a portion of their money in stocks, a portion in bonds, and perhaps a portion in mutual funds. That seems diverse enough, at least on the surface.
But in 2008, the S&P 500 lost 37% of its value. If you had a $500,000 portfolio at the time, you would have lost $185,000. Even people with money in mutual funds did not fare well.
And bonds? Well, when the stock market is volatile, some investors run to bonds, thinking that at least their principal will be safe and they'll reap perhaps a small return. But contrary to that popular belief, bonds don't guarantee a return on the principal and their value can, indeed, go down.
So, all that diversification didn't necessarily protect all those people who thought they were protected from a major loss.
But there's more than one way to diversify. Here are some things to consider if you want a little more balance for your investments:
- Alternative investments. Stocks, bonds and mutual funds aren't the only game in town. Investors desiring a low-volatility strategy should consider alternative investments, such as real estate, commodities and gold. These different types of investments are not only a hedge against market volatility, but they also can add value when stocks and bonds are not performing as well. Dividend-paying stocks. Some portfolios only include growth stocks, but adding dividend-paying stocks can be a key strategy for bringing more income to your portfolio. With dividend-paying stocks, you can have money coming in - in the form of quarterly payments - even when there's no appreciation to the stock's value. Certainly, the amount of that dividend will vary depending on the stock, but a combination of growth stocks and dividend-paying stocks can bring more diversity to your portfolio than just focusing on growth.
- Fixed-index annuity. If your goal is to build wealth and limit losses, a fixed-index annuity could be a good option. A fixed-index annuity, which is one of four types of annuities, can allow you to not only grow your money, but also receive future income in payments similar to a pension. One of the myths of annuities is that when you die, the insurance company that issued the annuity keeps any leftover money and nothing goes to your heirs. But that's just one type of annuity. Some high-net-worth people use fixed-index annuities for conservative growth and safety. Others might turn to these annuities because they worry about outliving their money, and they like the sense of security they can receive from those monthly payments for life. One caveat: Not all fixed-index annuities are the same, so do your research and make sure you work with a fiduciary who understands annuities.
Anytime you're seeking diversification, your hope is to minimize your losses and maximize your returns.
As you review your investments, the questions you should ask yourself are: Am I as diversified as I need to be, and is there a different way I can bring diversification to my portfolio?
See Also: Is a Target Date Fund Right for You?
Ronnie Blair contributed to this article.
Investment advisory services offered only by duly registered individuals through AE Wealth Management, LLC (AEWM). AEWM and Knoedl Retirement Advisors are not affiliated companies. Investing involves risk, including the potential loss of principal. Any references to protection benefits, safety, security, lifetime income, etc. generally refer to fixed insurance products, never securities or investment products. Insurance and annuity product guarantees are backed by the financial strength and claims-paying ability of the issuing insurance company. #229055
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