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Plan Well, Retire Well

Saving and investing your money

The death of diversification?


Some people have given up on diversification. You've heard or read about them - people who are so fearful that the current market downturn is the beginning of the end that they will only keep their money in US Treasury securities or insured bank accounts. Maybe you are one of them.

It's understandable. Even the most novice investor knows the mantra, Don't put all your eggs in one basket. Diversification is supposed to protect us. Everything isn't supposed to drop in value all at the same time. Thus, we own not just US stocks, but foreign stocks as well. We don't own just the stocks of large companies, but also small and mid cap companies. We have some money in bonds of US companies, foreign entities, money market funds, real estate investment trusts, even commodities. And we thought we were safe.

Now we feel that diversification betrayed us. The value of our homes, US stocks, foreign stocks, even bonds to a degree, all dropped in value. That wasn't supposed to happen.

To make matters worse, there seemed to be nowhere safe to run. There was even a scare about money market funds last fall.

So some investors have thrown up their hands and surrendered. They're not even going to try to figure out how to invest in hopes of keeping ahead of inflation and taxes. They're content to earn next to nothing on their money on insured bank accounts or US Treasuries, just so they can avoid the pain of perhaps losing more. They've given up on diversification.

But what does that mean for these investors in the long term?

The Alternatives

William Bernstein, columnist for Money Magazine and a hedge fund manager, sees two alternatives to using diversification. He discusses these in the April issue.

Everything in one basket, "and watch that basket," he quotes Mark Twain.

  • If that basket is Treasuries, you won't lose any money. But over time, after taxes and inflation, you'll very likely just break even or even lose value. That may be OK in the short term, but it means you're going to have to save one heck of a lot of money in order to have what you need in retirement or for your newborn's college education.
  • Or maybe you choose Wal-Mart and McDonald's as your "basket," since they are two of the few bright spots in this recession. What happens if hamburgers and french fries suffer the same fate as Krispy Kreme doughnuts? After its meteoric initial public offering, the low carb trend (and perhaps other factors) caused its stock price to drop from $12.60 at the end of 2004 to $1.68 at the end of 2008. Or perhaps Wal-Mart and McDonald's don't do poorly, but small US companies and foreign stocks outperform them by large margins year after year.

The point is that without diversification, without investing in a variety of assets, you make yourself vulnerable to other types of risks.

If you can't stand the heat, get out of the kitchen is the label Mr. Bernstein puts on his 2nd option. I'd call it market timing. This strategy says, when things get too crazy, I'll get out of the stock market. And I'll get back in when things are safer. Sounds great in theory, but in practice, almost nobody can make those calls on a consistent basis. That's the whole reason that few actively managed mutual funds beat index funds over the long haul. Making one prescient decision doesn't make you money; you have to do it time, after time, after time.

The Final Word

Well, it's possible that those who believe the sky is falling are right, and that US and foreign stocks will tread water or lose more value for years to come. But after considering the alternatives, for my money, I'll go with diversification.

For more about diversification and sound investment strategies, visit Plan Well, Retire Well and check out Choose Investments. Or join me and my colleagues for a workshop during Money Smart Week, April 18 to 25.



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