ENSURE DIVERSIFICATION OF CLIENTS` INVESTMENTS
Sure, your clients know they should not put all of their eggs in one basket when investing. But they tend to forget that saying. Advisors, you are much aware of the consequences of not diversifying their portfolio. Here’s how you can make sure their investments are properly diversified.
Many Holdings ≠ Diversification
Months before the Dotcom Bubble in 2000, Ken and Jen held 20 mutual funds. They felt their investments were well diversified. But the couple did not immediately notice all of their funds held shares of big firms in the Silicon Valley, including Microsoft Corp. The funds primarily invest in large cap stocks; hence, there was minimal diversification in terms of other asset classes with a low correlation to large caps. Upon learning this, their advisor urged them to change course and invest in other derivatives.
Too Much Company Stocks Can Kill You
Let’s take a look at Enron. Once upon a time, the company is a Wall Street darling and one of the world’s largest energy firms. But in collapsed in 2001 because of the practice of concealing the financial losses of their trading business and other operations. Senior management prohibited employees from selling their stocks (for at least 30 days). As a result, many employees lost massive amounts of money in Enron’s retirement plans and via shares held elsewhere. Even the world’s biggest companies are susceptible to demise. Holding too many company stocks can kill a portfolio.
Diversify to Maximize Profits and Minimize Losses
A T. Rowe Price Group Inc. study showed an all-stock portfolio would have averaged an 8.6% annual return between 1984 and 2014. But the all-stock portfolio, represented by the S&P 500 index, wiped out 37% in 2008. The average decline in the succeeding years was 16.6%.
From 1984 to 2014, all all-stock portfolio would have averaged an annual return of 8.6%, according to a T. Rowe Price Group Inc. study. But the all-stock portfolio, represented by the S&P 500 index, wiped out 37% in 2008, and the average plunge in the following years was 16.6%. Also, the study indicated a portfolio with stocks (60%), bonds (30%), and cash (10%) would have earned a median return of 7% over the same period of time.
The average decrease in the down years was around 6.7% over the 30-year period, while the worst annual fall was 18.1%. Conversely, the all-stock portfolio yielded 81% of the returns, with less than half of the risk.
A JP Morgan Asset Management study said the 12-month return on stocks, between 1950 and 2013, ranged from +51% to -37% over the rolling 12-month periods. For bonds, the range was +43% to -8%. A combination of stocks (50%) and bonds (50%) had a narrower range than either of these assets, which is +32% to -15%.
Asset Classes Constantly Change
Emerging markets equities were at (or near the top) of a chart during the last decade, based on a chart released by JPMorgan Asset Management. In 2015, they are on track for third consecutive negative yearly return. Markets are mercurial in nature, and so asset classes. Stocks are highly volatile, which pressed many advisors to inject ETFs and index funds to diversify a client’s portfolio.
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