When Diversification Fails
The above chart represents the return for nearly every combination of equity investments you could have made over the last year. No sector, style, world region or market cap escaped devaluing more than 25%. Compare this to the start of our last recession between 2000 and 2001.
Just within U.S. equities, proper diversification likely could have avoided 40% losses caused mainly by one sector. And, in fact, it was eminently possible to find a safe haven sector (ironically, financials) to hide from the carnage.
While The Curious Investor and most investing blogs our there focus mainly on equity investments, the past year has taught us that the old adage, “There’s always a bull market somewhere,” is not always the case for the equity markets. Or, is it?
Diversification is more than buying stocks in different industries and geographies
Risk comes in many types. Diversification through different companies and industries can help to insulate you only a few unsystematic risks namely industry risk, company specific event risk, and geopolitical risk. To properly diversify, you need to consider investments outside of equity markets – asset allocation.
Asset Allocation with a Brokerage Account
It can be difficult for retail investors to access non-equity assets. Most brokerages offer some access to U.S. Treasuries and other government or municipal bonds as well as a small amount of corporate bond placements. But, these can often come with significant fees or minimum investments. There is a more cost effective route. Ironically, these investment vehicles trade through typical stock exchanges. Just as The Curious Investor has previously discussed using ETFs and ETNs to create hedges and passive indexing, it’s possible to use ETFs and ETNs to gain access to assets outside of the markets.
For me personally, given the state of our economy and the likely pressures on the U.S. dollar as a result of policy actions to remedy the situation, I’m interested in adding commodity exposure (click to check out my rationale on gold and oil) and foreign bond exposure. It just so happens that there’s an ETF for all these purposes – IAU, OIL, and IGOV (and more if you look around). While the IGOV was brought to market less than a month ago, data for IAU and OIL show correlation of .20 and .33, respectively. About as uncorrelated as a risk asset can get and exactly what you’re looking for when properly diversified.
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Comments
RE: “… There’s always a bull market somewhere,” is not always the case for the equity markets. Or, is it?…”
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“… There’s always a bull market somewhere,” means ANY kind of market may be in a boom cycle, not just stocks. Yes, all stock markets may go down during a cycle, but, in the same cycle, gold may rise, chinese ceramics may spurt up, etc.
Very much agree with you. That’s why I wrote this article about the importance of asset allocation and not getting to strung up on finding winning “stocks” (in the traditional sense). Most of us retail investors, however, must use equity market vehicles to access other asset classes – i.e. through the use of ETFs and ETNs.
[...] various indexes from the Summer of 2008 until the end of 2008. As has been talked about by many, international diversification (and almost any sort of asset class diversification) failed badly in our unprecedented market slide in 2008. All the indexes fell at least 30% over the course of the [...]
diversification fails because of many reasons for example
mergers and acquisitions are not working togther,culture is not mataching not expertise in new product development .
i dont think so diversification and stock market dont have any direct link because ,diverisification business are related and unrelated ,related business have direct inpact on firm as well as its stocks in stock market, and most of the firms are got success in related diversification .But unrelated diversification got many firms unsuccess because not matches business and producat and services ,some firm doing jointventure with other firms and doing businesses but later their busniess fails becasue strategic partners are not working togther they use different idea’s for product and services. their managers are not agree with each ohter if they make any decision.
[...] seen the markets oscillate wildly but ultimately head only further down into its trough, sparing no one in its path. Was he wrong? Is it still not safe to get your money back into the stock [...]