April 7, 2020 Update: Gimme Shelter—Why Diversification Can Pay in a Down Market
Having a diverse investment portfolio doesn’t eliminate the risks of investing. However, it can pay off. How? By providing you choices that help reduce the impact of down markets if some of the portfolio has to be sold. In that sense, it’s wise to have a broad array of investments in your portfolio. And, since we’ve entered a bear market, let’s examine the benefits of diversifying an investment portfolio.
According to Merriam-Webster, when it comes to the world of investing, to diversify means “to balance (an investment portfolio) defensively by dividing funds among securities of different industries or of different classes.” In this context, “different classes” can mean stocks are defined as a different class of investment than bonds. Or, large company stocks are a different class of investment than small company stocks.
Here’s one example. Let’s say you need to sell something to get cash. If you have bonds in your portfolio, you may want to choose to sell some of those bonds instead of stocks. Having the option not to sell stocks, especially when the markets are down, demonstrates why it can pay to be diversified.
The theory behind diversifying is that various classes of investments are affected in different ways by changes in the market and economy. The differences mean that all investments don’t move in lock-step. That is, they are not either all up or all down at the same time, in general. Therefore, a diverse investment portfolio is deemed to be less risky than one that isn’t.
Having a diversified investment portfolio doesn’t mean that it is immune to down markets. During bear market periods such as we’re experiencing now, the overall value of a diverse portfolio of stocks and bonds is likely to decline. However, if some of the investments, such as bonds, don’t go down as much as the stocks, then the overall level of decline should be lessened. Dampening the overall volatility of your investment portfolio in a down market is one way that it can pay to be diversified.
Paul Hynes, CFP®
President and CEO