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Diversify Your Portfolio to Meet Your Financial Needs

By Doug Famigletti, CFA, Managing Partner & Portfolio Manager

Eggs In One Basket

It can take years to build a nest egg and days to lose it — but only if you put it all in one basket.

That’s why diversification or distributing your funds across asset classes to avoid depending on a single investment for growth is key to achieving your investment objectives.

Thoughtful asset allocation limits the amount of volatility your portfolio experiences and determines the way your wealth grows.

Why Diversify?

From 1926 to 2021, a portfolio of only stocks provided a 12.1% annual return on average, while a portfolio of only bonds came in at 6.3% per year. Cash barely outpaced inflation.

At the same time, over this period, you would have had to weather a 43% drop in your portfolio value if you had all your money in stocks. By contrast, the worst year for bonds in that near century produced a loss of just 8.1%.

The performance of asset classes will differ depending on the market conditions and economic environment. By spreading out your investments among them, you may smooth out the variability of returns, or “de-risk” the portfolio.

But how do you find the proper portfolio allocation for you? The answer comes down to your risk tolerance.

Is It Worth the Risk?

No one asset is a “better” investment than the next. Rather, each carries unique risk and return characteristics, including these common asset classes:

  • Cash investments — the most common are money market accounts, CDs, and interest-earning savings accounts are the least volatile of the investment classes, but also the least likely to produce a significant return.
  • Bonds – or corporate debt in the form of tradable assets, vary along the risk-reward continuum. Short-term treasury bills sit on the safest end of the spectrum, while high yield “junk” bonds carry risk levels comparable to stocks.
  • Stocks run the gamut from relatively conservative to high-risk securities. Within the stock market investors can diversify between growth and value stocks; large, medium, and small-cap stocks; sectors, such as healthcare, consumer staples, and energy; and geographic region.
  • Real estate will almost always grow in value over time, and typically adds inflation protection as well. However, it tends to require one of the largest up-front investments of any asset class.
  • Hedge funds tend to be distinguished by market agnostic return objectives, investment in a range of securities, and the use of derivatives, short selling, and/or leverage. Some managers seek to provide significant growth, while others offer more conservative risk-mitigation strategies.
  • Alternative investments can offer exponential returns but are often highly volatile. Cryptocurrency carries the added risk of scams and loss of wallet password. Be sure you understand the risks and tradeoffs of alternative investments before adding them to your portfolio.

Broadly, asset allocation strategies can be divided into three categories: conservative, moderate, and growth.

  • Conservative portfolios, for risk-averse investors, typically allocate more than 80% of their portfolio to lower risk categories such as cash investments and fixed income with a smaller amount devoted to higher growth areas such as stock.
  • Moderate portfolios are designed for growth with substantial downside protection. Given that yields on Fixed Income over the past 10 years have suffered, the traditional 60/40 portfolio model (60% stocks, 40% bonds) has been all but abandoned. In addition to Fixed Income, moderate portfolio investors are looking to other strategies to mitigate risk such as covered call options writing strategies.
  • Growth portfolios are for investors who can stomach long periods of volatility and resist temptation to sell when markets turn south. These portfolios typically allocate more than 80% of investments to stocks, derivatives and alternative strategies.

No strategy is “set it and forget it” as diversification is not a one-time decision, but an ongoing process. Rebalancing, or the shifting of assets to adapt to market conditions and match your original target weights, ensures your portfolio is continually pointed toward your financial goals. Take the first step toward designing a well-balanced portfolio today and set up a call today with an expert at Griffin Asset Management.