Diversification: Always Something To Celebrate (And Apologize For)

This may feel like an old, well-worn topic, but please bear with me; I hope to present a new twist.

Diversification is a time-tested way for investors to manage the inherent risks of investing by owning lots of different kinds of assets. Diversification takes many forms, but often looks like this example: owning 60% of a portfolio in stocks and 40% in bonds means you’d not lose as much of your life savings when the stock market drops (Celebrate!), thanks to the ‘safer’ bonds, BUT/AND you’ll not earn as much money when the stock market climbs (We apologize!), because you own those same ‘safer’ bonds. As a result, we’ll always have something to celebrate as well as something to apologize for.

Depending on your investing philosophy, the mood you’re in, and your overall approach to life, having these risk management measures in place usually feels good; it’s the prudent thing to do. However, if you feel that your timing always stinks, someone’s trying to take advantage of you, or you just possess bad luck, diversification can result in a very negative experience when it’s in-place. After all, always having something to apologize for, means you’re usually focused on what didn’t appear to work in your favor. Truth be told, that can wreak havoc on your investing experience because it can lead to abandoning the chosen investing strategy to chase some grass on the other side of the fence that always appears to be greener. The ins-and-outs and heres-and-theres can make it feel like you’re just not getting your fair share…and you’re right. Making moves because of these feelings have been shown to result in much lower returns than would have been experienced if not for the big moves at the most inopportune times.

The same diversification premise holds for annuities. If you want to be angry at guaranteed annuities, which provide any number of guarantees against market losses and outliving one’s money (longevity insurance), just wait for the stock market to rise dramatically. The performance ‘gap’ between annuities and stocks will make you wish you’d never laid eyes on – or invested dollars into – a guaranteed annuity. Sure, it’s an apples-to-oranges comparison, but we’re all susceptible to making this comparison. However, if you want to love guaranteed annuities, simply wait for the market to drop significantly (remember 2003 and 2008?), or live to an old age and wonder at the fact that income checks keep rolling in from the insurance company, long after your invested money would have run out. This performance ‘gap’ between annuities and stocks may look a bit different now.

The point? Diversification stinks…and is great. It all depends on how you diversify and how you choose to respond to the results of diversification. If you always look for the negative in a circumstance, diversification will give you plenty to detest. If you look for the virtues to be celebrated in a circumstance, diversification will give you plenty of reasons to rejoice. The choice is yours.

Ultimately, a building blueprint outlines a structure that uses many diverse materials (wood, steel, granite, stainless steel, etc.) and many engineering principles that should keep the building from toppling at the first heavy storm. Similarly, a well-crafted retirement plan utilizes many diverse materials (stocks, bonds, annuities, LTC insurance, etc.) to keep the storms at bay and the structure in-place.

As we continue to build our plans and hone our respective investing philosophies, I’ll look forward to many opportunities to celebrate with you and apologize to you. Thankfully, diversification isn’t going away anytime soon, nor is your ability to build true financial security using its virtues.