I emphasize the importance of diversification with my clients daily. You might say that “diversification” is my professional middle name. It’s a principle that requires consistent reinforcement because even the most diligent investor sometimes needs a reminder.
Here’s a common scenario: a successful professional approaching retirement is drawn to the idea of “buying straw hats in the winter,” leading to a portfolio comprised entirely of value stocks – those whose share prices are considered undervalued based on company fundamentals. While a position of, say, a hundred different value stocks might seem diversified at first glance, those stocks often move together in the market, which can lead to concentrated risk rather than the balance true diversification provides. I often show clients a chart comparing diversification across assets with low correlation (where prices move differently over time) to illustrate how a better-balanced portfolio can help manage volatility and smooth out some of the stomach-churning, roller-coaster changes in value they could experience in an equity portfolio where everything tends to move in tandem.
Another common situation involves clients who believe they – or I – can time the market. They expect that by jumping in and out of the market at “just the right time,” they can avoid the downdrafts and ratchet up their returns. For clients with this mindset, I typically turn to financial research showing how difficult it is to predict the market’s exact movements, especially over the long haul.1 By illustrating the concept with examples like Warren Buffett’s “long bet,” I can usually help these clients see the wisdom of establishing a strategy, diversifying appropriately, and allowing the markets to do what they do most efficiently over the long term.
Then, there are clients who prefer to keep everything in cash or near cash, often due to a strong fear of market risk. Unfortunately, this approach overlooks other risks, particularly inflation, which erodes purchasing power over time. (And even though inflation is much closer to being under control now than in 2022, it is still rising each year, eroding the purchasing power of every dollar held in cash). For clients with this mindset, my job is to help them understand that the future risk of failing to proactively grow their assets is at least as great as the present perceived danger of reduction in value due to market action. For younger clients in this situation, I often show them future portfolio values under various return scenarios. With interest on CDs, money market accounts, and short-term treasuries still near historic lows, I often ask, “Will you be able to live comfortably in retirement if your portfolio is only worth this much?” While the answer is usually “no,” it opens the door to a conversation about – you guessed it – responsible diversification, risk management, and other basic principles of good portfolio design.
As a fiduciary advisor, I have a responsibility not just to help clients invest their money, but also to help them become more informed investors. I spend the time necessary to accurately assess each client’s tolerance for risk and ability to understand and act on sound investment principles. Effective communication about tried and tested fundamentals underlying our strategies helps me equip clients for a much more successful and stress-free future.
If you’re not a client and would like to learn more, let’s talk.
1 Schwab.com. “Does Market Timing Work?” Schwab Center for Financial Research, 13 September 2023.
