If there is one concept to drill down when it comes to investing, that is to make sure you diversify.
The thing is, we have this tendency to lean into what we’re familiar with, among other behavioral biases. The result: Not properly diversifying your portfolio.
Exhibit A: Periodic Table of Asset Classes1
This is one of my favorite visuals to share with clients, as it does a great job at showing WHY diversification is important. We cannot expect the same asset classes to perform the same way they might have in the past. e.g. past performance is not indicative of future performance.
So let’s take a look: Each column reflects a calendar year, and the column is ranked from best performing asset class at the top to worst performing asset class at the bottom for that specific calendar year. (examples of asset classes are US fixed income, Large Cap Equity, Small Cap).
What I want you to take away from this, is that no asset class has been the top performer year after year.
The winners and losers rotate out. This is why it’s important to diversify, so we can take advantage of all potential winners, and not put all our eggs in one basket.
One major risk of being too concentrated in one asset class, is that if it doesn’t perform well, your portfolio is going to reflect that. While with investing, there are no guarantees, we want to mitigate our risk as best we can.
So how do we diversify better?
1. THINK GLOBAL - Especially small cap
It’s important not to neglect opportunities that may exist globally.
Large cap companies and small cap companies often have little overlap, meaning you should be investing in both to further diversify your portfolio.
International exposure, especially small-cap, is an often missed or forgotten opportunity in portfolios. International small and mid-cap investments have outpaced international large caps over the last 20 years.
Keep in mind, international markets tend to be a bit more volatile than US markets, especially the small and mid-cap companies, so don’t get overeager in your allocations.
2. Don’t be afraid of fixed income
I get it, talk of inflation and interest rates are making people wary of investing in fixed income. But that doesn’t deter from the fact that fixed income is another great way to add diversification in your portfolio. Fixed income adds stability to your portfolio, as it often has a negative correlation to equity markets.
One of my favorite ways to add fixed income to a portfolio is through a multi-sector or flexible bond fund. This strategy allows money managers to pivot between different fixed income sectors based on their market outlook.
This gives them the greatest advantage of being able to take advantage of the winners and ditch the losers as they see fit. Similar to the asset class periodic table above, fixed income sectors rotate their winners and losers.
3. Add in dividend payers
Whether you are in your accumulation years of investing or in retirement and taking distributions from your portfolio, dividend paying companies are a great way to further diversify your portfolio.
Income is a whole different strategy to investing than simply growth or capital appreciation. Most investors want to find companies that they believe will increase in value over time by growing their business. But another great way to increase the value of your portfolio is through dividend paying companies and reinvesting those dividends.
Dividend paying companies can be a positive sign of resilience, “Because they are committed to setting aside some proportion of their earnings for investors, they tend to have better discipline and may be less likely to make some ill-advised acquisition,” says Joyce Gordon, Equity Portfolio Manager at American Funds.
Pro tip: Reinvest those dividends to further compound your growth
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