Find Out More About:
Submitted by: Julia Lundstrom
You have heard over and over again that asset allocation or diversification is dead. Some people even call it de-worsification. But is it really?
It is true that in the last couple of years the traditional theories of diversifying your portfolio have changed. There used to be a time not so long ago that if stocks went up, bonds went down. If stocks were in a decline, gold or oil were rallying. Now it seems more and more that uncorrelated asset classes are now following each other on the ups and downs.
Small cap stocks correlate with large cap stocks. Large cap stocks correlate with international stocks and even with corporate bonds. Heck, even gold has rallied at the same time the stock market has for the last 2 years. The traditional hedges, for instance, buying gold while stocks plummet, dont seem to protect your portfolio from the downside risk as much as it used to.
But does that mean asset allocation or diversifying your portfolio will reduce your returns or worse, is it a dead science?
We still want the scenario that if one asset class tanks another will increase to reduce your risk and give you better overall returns. So, how do you get it?
Lets look at some numbers. The correlation of different asset classes from 1978-2010 have increased as compared to the S&P 500 in everything from Small Cap stocks to Bonds and Commodities by a minimum of 13%. In the case of bonds it is two times as correlated today than in 1978.
The result: traditional asset classes are moving more and more together over time.
Commodities (gold, agriculture, pork bellies, etc) historically have had very little correlation to the stock market. Now for every $1.00 that the stock market gains, commodities go up $0.58 more than half. Some of the biggest changes have been in the correlation of international stocks to domestic stocks. As the world gets smaller and countries become more dependent on each other for their economies, this makes sense.
So what do you do about it? Diversify better! There are always new ways to diversify more in alternative investments and other asset classes. The sophisticated money is investing in currencies, commercial and global real estate, hedge funds and managed future funds and more. This is overwhelming for the average investor, but it really doesnt have to be. You dont have to be a multi-millionaire in todays market in order to invest in these areas now that there are mutual funds, Exchange Traded Funds (ETFs) and Real Estate Investment Trusts (REITs).
Diversifying still works and there is proof.
If you add just one component from an alternative investment like a hedge fund, you will actually reduce your risk by almost 2% from a traditional stock and bond portfolio. You can see the chart for yourself at www.refinedassetallocation.com/strategy.
What this shows is that the diversify and invest and forget about it methods of investing dont work anymore. You have to delve deep into your investments and decide not if you should invest outside of simply stocks and bonds, but exactly what percentage of your portfolio is best in each asset class.
Visit the returns at www.refinedassetallocation.com/returns to see the evidence that asset allocation works. Everything from a High Risk Portfolio to a Low Risk Portfolio is beating the traditional stock-bond blend and with a lower amount of risk.
Diversifying still works, you just have to broaden your horizons and open your portfolio to investments you traditionally thought were too risky. Your stock and bond only portfolio is riskier.
About the Author: Julia Lundstrom is a Certified Financial Planner with over 20 years in Investment Management and currently writes for
refinedassetallocation.com
and manages SilverBack Managed Futures
Source:
isnare.com
Permanent Link:
isnare.com/?aid=925915&ca=Finances}