Diversification
Investors are learning about diversification in real-time as markets react to news in Ukraine. Stocks are falling, and gold is rising. Before the invasion, stocks had been a one-way trade as the S&P 500 soared 272% over the past ten years, averaging 14% per year, far outpacing most investments. Stocks trounced bonds, gold, oil, and international investments. If you concentrated your bets in large-cap stocks, you nearly tripled your assets, but your returns were less if you diversified your assets.
After the invasion, however, the script has flipped. The S&P 500 has entered correction territory, and gold and energy investments are up considerably.
Diversification is the key to investment survival because it's impossible to predict which market will do well from one day to another. No one predicted COVID-19 or Putin's invasion of Ukraine, so the best offense is a good defense. It's rare for investors to concentrate their holdings and hold them forever because most people can't stomach the downturns. Investors are bold when stocks rise but run for cover when they fall. To capture long-term returns from equities, you must endure a few years of negative returns as stocks do not rise in a straight line.
Diversification is discussed often on Wall Street, but what does it mean to own a diversified portfolio? At the core, it means allocating your assets across stocks, bonds, and cash – stocks for growth, bonds for income, and cash for liquidity.
The S&P 500 has generated an average annual return of 10% since 1926, but it also experienced several dips. Add small-caps, international holdings, and emerging market companies to diversify your holdings further. Global equity exposure reduces your risk, but be careful against single market risks like China and Russia.
Bonds provide income and safety. Bonds can consist of US Treasuries, corporate, and municipal bonds with maturities ranging from months to centuries. Diversifying your assets across bond types and maturities can further protect your assets.
Cash is king and liquid. Checking and savings accounts, CDs, T-Bills, and money market funds are excellent reservoirs for cash investments. Allocate money to a cash account if you must access it in one year or less. Also, park your money in cash if you take distributions from your IRA, 401(k), or investment account. For example, if your monthly distributions are $10,000, consider allocating $90,000 to $120,000 to your cash account. When your cash balance falls, replenish it by selling stocks or bonds.
The S&P 500 is down 10% on the year, but a balanced portfolio of 50% stocks and 50% bonds has only declined 4.5%, buoyed by the bond and cash allocations. However, over the past ten years, the all-stock index has trounced the balanced portfolio by a 2 to 1 margin.
Our diversified models invest in several asset classes: technology, industrials, financials, healthcare, consumer cyclical, consumer defensive, basic materials, real estate, communication services, and energy. The models own several thousand securities sprinkled around the world.
As long as Putin continues to bombard Ukraine, the volatility will continue, so diversify your assets and follow your plan. If your time horizon is five years or more, buy stocks. If you're young or don't need money in the near term, falling stocks allow you to purchase great companies at lower prices. If you need money in the near term, keep your funds in cash and do not buy stocks.
Be fearful when others are greedy, and be greedy when others are fearful. ~ Warren Buffett
March 7, 2022
Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management, located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM's custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.
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