Investing in a Down Market – Diversifying

    Published: 06-16-2009
    Views: 10,833
    Finance Expert Tom Cymer discusses diversify your investments in a down market.

    Thomas Cymer: Hi! I am Thomas Cymer, financial planner and founder of Opulen Financial Group. And I am talking about investing in a down market. Right now I will be discussing the first step into protecting your assets, diversify, diversify, diversify. No one can predict the future or tell you what the markets are going to do next. But history shows us their returns vary from year to year and different types of asset classes perform differently over time. So how does the performance of different asset classes vary? Well, this chart shows the performance of different types of investments. Treasury bills, as you can see have a smoother although somewhat lower performance. Cooperate bonds on the other hand, historically have a slightly more volatile performance but as you can see have been move smoother since the early 90s. Stocks tend to fluctuate with more higher peaks and lower values. But generally have a greater return over a long term. As an example of real estate investment trust or REI is seen in green. You might expect REIs have been quite volatile over the past five years. Now let's talk about how diversification could help you manage your volatility.

    Diversification spreads out risk over a group of investments. For example, your portfolio of stocks is more diversified when you hold an array of companies of varying size. For example small, mid size and large companies. Industry and location is also a way to diversify your assets, US based or international rather than the limited number of similar companies. For example, all US based large technology companies. Diversifying diminishes the prominence of any one stock. Now let me show you an example of how diversification can actually work. Let's say, that Ben and Ken each have $10,000 to invest and they both plan to stay invested for 25 years. I realize this may be a longer time frame that might be interested in but it's helpful for an example purpose. In this scenario Ben decides and invests his $10,000 in one hypothetical investment, earning 6%.

    Ken decides diversify. He invests $25,00 equally among four hypothetical investments. Ken's first investment was a complete loss, $2500 never to be seen again. The second investment provided a 4% return, the third investment provided an 8% return. And the last investment hit a home run and earned the 12% return for the entire time period.

    So how do they fair in the end? Let's take a look at Ben first. With a 6% rate of return, it's a 12 years for Ben's money to double. And they were just over two doubling periods during the 25 years he invested. Ben ends of approximately $42,919.

    Now even though Ken lost the first $2500 out rate, his diversified mix reached the total of 66,286. Having a more aggressive portfolio allowed him to achieve higher returns. But diversification controlled the volatility and his risk. These ways of return I chose them for illustration purposes only.

    Actual rates of return on investments do fluctuate. And diversification alone is not a guarantee of higher returns, plus taxes have also not been included. But the point remains, Ken had 50% of his money earning less than Ben's 6%, but still came out more than 50% higher. The moral of the story is diversify, diversify, diversify. I can't stress this enough. Now keep in mind the example shown here may or may not be appropriate for you. And my goal here today is simply to introduce some strategies that may help you in the long term. Now what about Asset Allocation? Well, Asset Allocation combines different asset categories, stocks, bonds, real estates, and cash into portfolios to target particular investment goals. Factors in choosing assets include your time line, overall goals, and tolerance for risk. Think about it, consider how an architect never designs a house of just one or two weight bearing walls. Instead the weight of the roof and the upper floors are distributed evenly to numerous load bearing walls. What happens ideally if one wall fails, the other wall saved the building from collapsing all together. Likewise, your portfolio of an investments should be assembled to no one single investment or asset class is carrying most of the load. If one falls, the other maybe able to offset that loss.

    Next, we will discuss controlling your emotions and avoiding market timing.