Diversification in Action

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Diversification is a great way to reduce the ups and downs in your portfolio.  This morning, the effects of the earthquake in Japan and related issues around their nuclear reactors are wrecking havoc on stock markets around the world.  The Japanese market was down about 10.6%, Germany’s market was down about 4.8% and the US market (as measured by the S&P500) opened down about 2.5%.

How does this prove that diversification works if the major stock markets are all down on the same news?  The answer lies in the yield of US Treasuries.  The price of bonds is up and the yields on 10 year treasuries has fallen about 3%.  If you already own Treasuries or mutual funds that hold Treasuries, this part of your portfolio is up, while the stock or equity side of your portfolio went down.  In “finance-lingo”, this phenomenon is called a “flight to safety”, as the world, not just US investors, views US Treasury Bonds as a safe investment to hold in times of uncertainty.

Most of us will see that our total portfolio value right  now is lower than it was yesterday.  This should happen when there is a major catastrophe in the global marketplace.  As an investor, not a speculator or market timer, the key to success is find the balance between risk and safety.  If we don’t take any investment risk, it is very difficult to meet long term goals and we will worry about running out of money in retirement.  If we take too much investment risk, we may panic when things get rough.  In “finance-lingo”, this process of deciding how much and where to invest is called “asset allocation”.  The amount of money we should put into the different market segments is different for everyone.  Some of the biggest factors to consider are how we handle the ups and downs of the market, how long until we need to use the money and how close we are to meeting our goals.

If today’s sell-off has you worried, you may need to re-examine how your portfolio is divided and take less risk.  If you are looking at today’s sell-off as an opportunity to “buy low”, you may want to consider a more aggressive investment approach.

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