The turmoil in the markets in 2022 has demonstrated the benefits of diversifying your assets. Stocks plunged, rebounded, plunged, and stabilized… but are still negative YTD.
So, how do you figure out how well your asset mix is diversified, and not too heavy in one area – like stocks?
Seasoned investors are used to spreading risk across multiple investments, such as stocks, bonds and commodities. Professionals, however, take it a step further: measuring “correlations.”
Without getting too technical, assets with a correlation of +1 move exactly the same in response to market developments. That would be painful to a portfolio if bad news prompted all the assets to fall in tandem. Assets with a correlation of -1 move in opposite directions. This, too, poses problems by curbing a portfolio’s gains in response to good news.
The preferred correlation: anything less than 1. That’s when the benefits of diversification are more likely to kick in. For example, a portfolio with two securities with a correlation of 0.72 will move in the same direction. Both may fall in a market downturn, but one might not fall as far.
Knowing Market Risks
Remember that market risk is always present. It comes in all forms: accounting risk, business risk, country risk, default risk, financial risk; and government risk.
What would have happened if you had invested solely in junk bonds or bitcoin or only in a single stock? Diversification only minimizes risk. Using statistical correlation allows you to refine your investment selections to lower risk even further.
Smart diversification should be the goal of every investor. Yes, it’s true that generally speaking, the more securities you add to a portfolio, the lower the risk. But that is only true up to a certain point.
Another caveat: Proper diversification limits a portfolio’s gains in a bull market. If the S&P 500 increases 30% next year, don’t expect the same from a diversified portfolio. That’s tough to deal with when the stock market is surging. On the other hand, the same portfolio won’t likely mirror a 30% drop in the S&P 500 – a welcome tradeoff for many investors.
Here at West Advisory Group, we understand that retirement years are not linear – far from it. These years have many peaks and valleys along the way.
Without the right strategy and guidance, these market rollercoasters can leave families scrambling when they don’t have to.
There’s a better way, %FIRSTNAME%.
We’re here to guide you through the unexpected, and give you a strategy that covers all of your retirement years – not just the golden ones.
We’re happy to talk you through your concerns, answer any questions, and give you peace of mind when it comes to what might be ahead on your retirement horizon. You can reply back to this email, or you can give our office a call.