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Why You Hate Diversification

Drew Harper, CFP®, CFA - Thursday, October 15, 2015

Diversification1015.jpgI would guess that you’re a rational individual that wants to own or associate with the best and distance yourself from the inadequate. This happens every day: you stop watching the Colorado Rockies (unless you have extreme hope or you’re a rare devoted fan), attempt to send your children to the best school, buy a larger house, dump your old car, and sell that investment your advisor told you to own for “diversification” purposes.

When you diversify, chances are your portfolio may underperform the best performing asset class in the short run. Ultimately you may feel like you don’t own enough of the best performer. For example, you have hated certain asset classes in your portfolio, such as commodities. However, your favorite asset class/position can quickly turn into the most hated.

You will (if you have not already) want to make changes. If you act on your desire to sell the junk and buy the great, it will lead to losing the investment game. Do not act on your rational desire to consistently own the best. The best action is usually inaction.

Don’t continually adjust your portfolio or asset allocation to an “optimal” one as nobody can tell you with complete accuracy what that will be. The complexities of financial markets across the world are impossible to forecast.

Evaluate your current portfolio in context of your goals, confirm that you have a strong probability of meeting your goals, and most importantly: don’t change your plan now unless your goals have changed. 

As we and many others have said before, the only rational way to approach investing for the long-term is a diversified portfolio, which won’t necessarily help you make a killing, but it also won’t get you killed. A rational diversified portfolio will help you control your risk in order to reach your goals as we believe controlling risk is more important than stretching for higher returns.

Understand what you own, stay invested, rebalance, and eliminate changes based on emotions. If you keep to your well thought-out plan, you will eventually love diversification.

 

 

 

Any opinions are those of Mark Smith and not necessarily those of Raymond James. Diversification and asset allocation do not ensure a profit or protect against a loss. Investing involves risk and investors may incur a profit or a loss. Every investor's situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Prior to making an investment decision, please consult with your financial advisor about your individual situation.

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