What is the True Meaning of "Diversified Investment Portfolio?"
stock market (Photo credit: 401(K) 2012)
You have probably heard for years from investment advisors, the media, your stockbroker, friends, and family that your investments should be diversified. Â In 2008, you probably learned that diversification across a broad array of stocks and stock mutual funds doesn't help you if the entire stock market craters at the same time. Â Lately, it seems that mutual fund investors are moving away from the stock market back into bonds for "safety," but what happens if/when the bond market craters? Â Timing the market is notoriously difficult to do and yet it seems like investors today are embracing market timing more than ever because the "buy and hold" mantra is no longer believable. Â You just have to look at the stock market over the past 5 years to see that the winners are the ones who bought at the bottom in early 2009 and are now enjoying the run-up - just waiting for the right time to sell. Â Investors who are still holding since 2008 (if there are any) are still looking at a loss.
Diversification isn't about having a bunch of different stocks or bonds or mutual funds that invest in stocks and bonds. Â It's also not about market timing or picking a winner. Â It's really about making sure that you can make money in any market situation and not lose 30%-50% or more of the value of your portfolio in a bad market stretch. Â Having all of your money in cash is also troubling given the fact that as much as everyone wants to believe it's not true, the value of the dollar is declining every day and there is real inflation out there, even if the official Consumer Price Index measure isn't showing it..
What would a prudent investor do, then, to protect themselves by using diversification properly? Â Here's a sample investment strategy that would meet these objectives in today's investment environment:
Stocks - 20%
Include international, domestic, emerging markets - some of these are really beaten down now, especially Europe and emerging markets (caution: Â may not have seen the bottom, yet)
Index funds should be part of the mix - low costÂ
ETF's are better than mutual funds, especially for 401(k) accounts if available
Don't be afraid to pick one or two good companies and hold on to them - Warren Buffett has done pretty well with that strategy over the years
Bonds - 20%
Pick a good bond manager with a good track record - I like PIMCO or BlackRock, unless you want to do all the research and evaluate credit quality of issuers
Include different sub-markets - municipal bonds, Treasuries and corporate bonds, including some high yield exposure
Real Estate - 20%
Feels like a good buy now, especially with historically low interest rates
Investment property - positive cash flow; moderate leverage (70% to 75%)
Better to own directly if possible vs. owning shares in a REIT that can go up and down with the stock market, plus you have control over the asset and business
Requires some time to manage as a business, but also has tax benefits
Alternative Investments - 20%
Silver, gold or platinum - physical coins or bars are better than ETF's for this category, in my opinion
Shares of mining companies are interesting, but you still have business risk and also general stock market risk in the event of a correction
Oil and gas master limited partnerships offer high current income yields (6% - 8% or higher) with commodity upside (downside is usually hedged - some MLP's are better than others at this) - pipeline MLP's offer yield but minimal commodity risk if that interests you
Cash - 20%
High yield savings, short-term commercial paper can offer attractive yieldsÂ
Keep some FDIC-insured accounts just in case
I wouldn't advise making any major moves into the stock or the bond market at this time, due to the high valuations and perceived level of risk. Â Averaging in over time to hit these targets would make the most sense so you can take advantage of market pullbacks, which are sure to continue, driven by the US election cycle, economic news and the situation in Europe. Â I feel better about current Real Estate and Alternative Investment valuations and would be a little more aggressive in diversifying into these categories at the present time.
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