The Power of Diversification: Building Portfolios That Withstand Market Cycles
Diversification is fundamental to developing long-term investment strategy that allows investors to navigate ever-changing markets. In simple terms, the concept of diversifying your portfolio generally means “not putting all your eggs in one basket” but involves spreading the investments in your portfolio across asset classes, sectors, and geographies, which reduces exposure to any single risk. It is important to remember that diversification doesn’t eliminate risk, but can help manage it.
Prioritizing true diversification in a portfolio involves investing in different asset classes: stocks, bonds, and alternative investments such as real estate. Investing in assets that don’t move “in tandem” helps keep a portfolio balanced. When assets are “negatively correlated,” that means they are moving in completely opposite directions. For example, bonds often have a low or negative correlation with stocks. As stock prices fall during an economic downturn, investors might seek the safety of bonds, which causes the prices of bonds to rise. This example shows how when one market lags, investments in another market may offset the losses in your overall portfolio. True diversification in a portfolio also emphasizes diversity of assets from different geographic regions and sectors.
Markets move in cycles. There are expansions, peaks, contractions, and recovery periods. No single investment performs well in every environment, and this is where diversification becomes valuable. In times of strong economic growth, equities are attractive to investors by providing them with higher returns. But when markets contract, more defensive assets – such as bonds, cash equivalents, or alternatives – can help offset losses. A well-diversified portfolio blends different types of assets in a way that cushions a portfolio against volatility. The key is the ability to stay invested. Diversification doesn’t guarantee gains or remove risk altogether, but it allows the investor to weather the storms of ever-changing markets.
Diversification is not a “set it and forget it” strategy. It is important to emphasize rebalancing and maintain ongoing oversight of investments in a portfolio. As markets fluctuate, portfolio weight adjustments are crucial; if stocks outperform, risk exposure is altered. Periodic rebalancing allows the investor to stay aligned with target allocations. Because market changes are continuous and rebalancing is necessary, professional oversight is essential. Having a financial professional oversee your investments and monitor their performance allows investors to stay aligned with their strategies, taking the emotional factor out of things out of the equation. A financial advisor can help identify the right mix of investments for your portfolio based on your risk tolerance, time horizon, and short- and long-term goals.
Diversification provides balance in a portfolio. It doesn’t eliminate all risk, but it eases volatility and can help you, as an investor, remain confident through uncertain circumstances. It is important to remember that diversification is a process, not a one-time decision. Having a financial professional involved in the oversight of your portfolio simplifies the process and removes the emotional bias from decision-making. If you’d like to review how your portfolio is diversified and aligns with your goals, our team is happy to help. Schedule a time to talk to one of our experienced advisors.