You own a fair number of large-cap funds and small-cap funds. You sprinkle in some “growth” and you add in some ”value.” What’s more, your portfolio combines a pocketful of U.S. stocks as well as a handful of foreign names.
Unfortunately, mixing different types of stocks and stock funds does not mean that you own a well-diversifed portfolio. Worse yet, far too many investment advisers couldn’t tell you the true, statistical meaning of diversification… even if you asked the question!
When hedging, you’ll remember, you want to own assets that move in opposite directions; your assets should have high negative correlations. When diversifying, however, you want assets to move independently from one another; your assets should have low correlations… positive or negative. The lower the correlation, the less the relationship and the better the diversification.
For example, if you own the SPDR Select Energy Fund (XLE), you might consider a “Dividend Aristocrat” like Abbott Labs (ABT). The 3-year correlation coefficient is only 0.27; neither zigs or zags on the same exact schedule.
Indeed, one might surmise that an economically sensitive sector investment such as Energy (XLE) might not move in the same fashion as a defensive health care company like Abbott Labs (ABT). One might even recognize that there is diversification between the investment type — one is an exchange-traded fund and one is an individual corporation.
At Pacific Park Financial, Inc., we understand that diversification is more than a word… it involves strategic decisions. In contrast, there are those who would have you believe you are diversified when you own the Energy Select SPDR (XLE), Canada (EWC) and Global Materials (MXI). The problem? These investments all have high correlations such that they all will move in the same direction 95% of the time.
One way to get greater diversification in your portfolio is to use different asset classes — from currencies to commodities to bonds. However, traditional asset allocation alone will not give one the diversified portfolio he/she seeks.
For instance, when constructing a portfolio, advisers may or may not realize that many investment grade corporate bonds and most G-10 currencies have high correaltions with the S&P 500 SPDR Trust (SPY). On the other hand, one who is more strategic in his/her efforts to diversify would seek out the non-relationships, such as combining iShares Mortgaged Backed Security Bond (MBB), Market Vectors Chinese Renminbi (CNY) and the S&P 500 SPDR Trust (SPY).
Please click this link to discover how “Targeted Asset Allocation” at Pacific Park will help protect your investment dollars.