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The Path to Diversification
Financial Professionals Can Help Navigate Pitfalls
You may know an investor like "Ralph." He swears he was diversified in the late 1990s before the equity markets retracted. "After all," he insists, "I had five mutual funds."
What Ralph didn't say, and maybe wasn't even aware of because he based his buy decisions strictly on performance, was that all five were large-cap growth funds. Diversification? Hardly. It's not unlikely that the overlap in all the funds meant his investments were controlled by a small group of stocks. That's why the value of his portfolio is half of what it was before March 2000 — even after significant appreciation over the past year.
Diversification is often easier to talk about than to understand — or achieve. That's why the value of an objective financial professional has become increasingly important.
"In some cases, a financial professional's role is to get clients to do what they might not do on their own — for their own good," said Jim Guilfoil, Russell's US National Sales Communications Manager.
By investigating a client's needs, tendencies and investing experience, a financial professional can craft an investment policy statement that mutually defines risk parameters as they relate to expected returns across an appropriately diverse collection of assets. Selecting investments can then be done in the context of finding those that complement each other rather than compete with each other.
Ideally, the implementation and monitoring of the designated portfolio provides the investor with greater potential to achieve defined goals. Most importantly, those goals can be pursued with management of risk and volatility in mind, helping to pacify an investor's anxieties.
"Financial professionals aren't always just stock pickers," Guilfoil says. "They create a holistic financial plan, which may include insurance components, estate and business planning too. Then they help the investor stick to the plan. Investment vehicles are just the means to fulfill it."
The Importance of Staying in the Market
Just as a personal trainer motivates someone to stick to a health and fitness plan, a financial professional's expertise encourages an investor to stay in the market through its ups and downs. The advantage? A retreat to cash eliminates any opportunity to take part in a rally from the start.
"Investors who go out of the market during difficult times, then jump in only after it has roared back, tend to buy high and sell low — the opposite of conventional wisdom," Guilfoil said. "This explains why money flowed into US fixed income investments last March when US bond prices were peaking, then flowed into US equities in August as the market corrected itself upward."
Prudent investing plans also encourage holding a reasonable percentage of asset classes and styles when they are out of favour. Investors are often better off not just to stay in the market but to stay in all of the market.
For example, by 1998, many investors had abandoned US small-cap stocks due to their mediocre performance over the previous five years. Of course, in 1999, small-cap, as measured by the Russell 2000® Index, outperformed large cap (Russell 1000® index) for the first time since 1993 and large-cap hasn't reclaimed the lead yet. But if an investor now has a significant small-cap tilt to their portfolio, they may not be positioned to take part in large-cap any rally.
The willingness to hold out-of-favor assets and the counter, overloading on recent assets of excess return, both reach the core of willpower and psychology of investing. It is at this level that the relationship with a financial professional can be most beneficial.
Real-World Expectations
Ultimately, a sound financial plan is one weighted toward balanced perspectives that don't waiver when a stiff breeze temporarily changes the way the market-leading flag blows. Knowing your asset allocation has been confirmed by a professional to be diversified and in tune with realistically attainable goals that equate to your risk tolerance should be comforting, if not exciting, as your future is unveiled.
Ultimately, investors with diversified assets and an understanding of why they hold what they do will have "charted their future based on reality, not wishful thinking," Guilfoil said.
This is a publication of our parent, Frank Russell Company. It should not be construed as investment, legal, or tax advice. The contents are for general information purposes only, and you are urged to consult your own investment, legal, or tax advisor concerning your own situation and any specific investment questions you may have. For further information about these contents, please contact Frank Russel Canada Limited.
Diversification does not assure a profit or guarantee against loss in declining markets.
Past performance is not a guarantee of future performance.
Russell 1000® Index: Measures the performance of the 1,000 largest companies in the Russell 3000® Index, representative of the US large capitalization securities market.
Russell 2000® Index: Measures the performance of the 2,000 smallest companies in the Russell 3000® Index, representative of the US small capitalization securities market
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