Diversification is a good thing. It also can be disastrous.
For example, an investor with a 20-year horizon for his long term portfolio might be holding 60% stocks and 40% bonds. If he happens to believe stocks are the preferred investment for this money, the question is “Why is almost half of your portfolio in bonds?” The answer typically is to smooth out short term volatility of the stock market. Notice this answer contains “short term”. So, a good part of his long-term money is now invested with a short term goal. How do bonds perform long term compare to short term? That difference can become a brutal cost in this example. Also, is there a real financial benefit to smoothing out short-term volatility? Or, is it a non-financial benefit, like peace of mind, or the ability to sleep. These might be nice, but there can be a very large cost in long-term underperformance. Cash and bonds can be very expensive shock absorbers for the jittery long-term investor.
Diversification has obvious benefits to the ‘diversifier’. The client is, or should be, focused on the end result. Not necessarily so for the financial advisor. His financial interest is not in the result, but in the process. Understandably he wants a client who is not unhappy and who pays a steady stream of fees. Diversification and regular reallocation of funds is key. What’s good for the broker, though, might guarantee mediocre investment results for the client.
Periodic reallocation of assets involves market timing, plain and simple. You might be hard pressed to find an honest history of successful market timing. Attempts at timing economic trends, combined with punishing diversification could spell unachieved goals over time.
To diversify is good. To digress is not. What is this costing me in long term performance? What are the benefits? Those must be the serious investor’s challenges to diversification.
We believe in diversifying… as long as it enhances, not takes away from long-term performance.
There is no guarantee that diversifying a portfolio will ensure better performance. Investing in equity and/or fixed income securities involves certain risks and the actual return and value of a portfolio invested in equity securities will fluctuate and at any point in time could be worth more or less than the amount invested