The False Premise of Diversification


Just diversify across asset classes and you’ll be protected from all potential harm. Or so the story goes from Wall Street, and the many Wall Street minions across the brokerage world.

Just buy a smattering of stocks and/or mutual funds, hold for the long term, and all will be right with the world, and your financial security.

Everywhere I turn it seems the same old story continues. Diversification, Buy and Hold, Modern Portfolio Theory, the beat goes on and on.

Have they all forgotten the two devastating bear markets of the last 10 years? Are they not aware of the hopes and dreams that have been dashed, retirements postponed, net worths crushed?

Or do they just move on, glossing over the serious shortcomings of the aforementioned Wall Street ‘wisdom’?

I have moved in the opposite direction in recent years. I no longer build and manage portfolios containing 10 to 12 mutual funds, or 18 or more stocks. Each client portfolio now owns a maximum seven individual funds, stocks, bonds, or combination of each. We selectively buy assets as we always have. We just buy fewer of them.

The management philosophy is to buy fewer eggs for our baskets, but watch those eggs very closely, and place a safety net under them. The safety net is the ‘stop loss’ measures placed under each security we own, as well as the overall market(s).

I believe asset protection is much more important than diversification. Asset protection means we have a series of rules to protect us from market meltdowns, regardless of the market involved. Whether precious metals, real estate, commodities, bonds or kumquats, we have an exit strategy for each.

The exit strategy for individual securities ranges from a 5% decline from trailing highs for high quality bonds to 8% for broad based stock funds, to as much as 12% for more volatile stocks and stock funds. If the securities we own pierce those levels they become candidates for selling.

We also monitor specific indices to track the various markets, always measuring whether they’re in bull or bear market territory. We rely on the usual technical indicators including Moving Averages, but also incorporate On Balance Values, Money Flow, and others into the mix.

It’s true I’ve had ‘safety’ strategies in place for a number of years and they have protected us, to a degree. These strategies and indicators helped save us from the horrendous declines in 2008, and even the bear market that persisted from 2000 – 2002.

Today’s strategies have been upgraded from those in place in past years. They are more formalized, relied upon more heavily, and implemented more readily.

Remember, no one can afford to lose 20%, 30% or more of their portfolio, no matter the age of the individual. This is particularly true of anyone nearing retirement age.

Always, always have an ‘Exit Strategy’.

Comments are closed.