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The myth of stock diversification – Lowell Sun

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At the end of 2007, many individuals had the vast majority of their retirement savings invested in stocks. According to the Employee Benefit Research Institute, nearly 1 in 4 Americans ages of 56 to 65 had more than 90 percent of their retirement savings invested in stocks. Another 40 percent had more than 70 percent of their savings invested in stocks. The following year, stocks lost nearly 40 percent, wiping out billions in retirement savings.

After losing more than a third of your retirement savings back in 2008, you told yourself that you were never going to let that happen again. Before the next bear market strikes, “you are going to be prepared.”

Many investors have been led to believe that diversifying across various asset classes of stock funds will help protect their portfolio from sustaining significant investment losses. Unfortunately, nothing could be further from truth. The problem is that when the stock market suffers significant losses, most all asset categories of stocks suffer significant losses as well. The fact is that a portfolio fully invested in various asset classes of stocks does little to protect an investor from sustaining a significant loss during down markets.

The accompany chart shows how three asset classes of stocks (U.S. large stocks, U.S. small stocks, and International stocks and U.S. Treasury bonds performed in 1973, 1974, 2000, 2001, 2002, and 2008.


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The last column shows how a diversified portfolio of 50 percent stocks and 50 percent bonds performed. During these five years, all three asset categories of stocks not only lost money, each asset class suffered an average annual return loss of more than 20 percent. U.S. Treasury Bonds had positive returns in all five years, and earned an average annual return of more than 10 percent.

When it comes to investing, the goal is to increase your savings, but not at the risk of jeopardizing your lifestyle or your financial security. While more money is always better than less, at some point in time the increased level of risk needed to try to achieve a higher rate of return, should no longer be the goal. The reason is that the potential damage of an unexpected negative outcome that reduces wealth far exceeds the potential benefit of an unexpected positive outcome that increases it.

During a bull market it’s easy to lose sight of the value of bonds. In bull markets most stocks go up-even the dogs. However during bear markets most stocks go down-even the bluest of the blue chips. During the bear market from October 2007 to February 2009, not a single U.S stock fund made money.

Individuals who invest most or all of their retirement savings in stocks tend to overlook the level of risk they are potentially exposing themselves too. If you can achieve your retirement goals by investing only 30 percent or 40 percent of your retirement savings in stocks, why take the additional risk of investing 90 or 100 percent in stocks? Yes, there is a chance that you could end up making more money; however, as many individuals experienced in 2008, taking a higher level of risk caused them to delay, or even cancel their retirement plans.

Martin Krikorian is president of Capital Wealth Management, a registered investment adviser providing “fee-only” investment management services located at 9 Billerica Road, Chelmsford. He is the author of the investment books, “10 Chapters to Having a Successful Investment Portfolio” and the “7 Steps to Becoming a Successful Investor.”

Martin can be reached at 978-244-9254, Capital Wealth Management’s website, www.capitalwealthmngt.com, or via email, info@capitalwealthmngt.com