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-diversified portfolio. Worse yet, far too many investment advisers couldn’t tell you the 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 Health Care Fund (XLH), you might consider a “Dividend Aristocrat” like Abbott Labs (ABT). The 3-year correlation coefficient is only 0.27. In other words, even though they both represent the same industry, each marches to its own market beat. You even get diversification of market access because one is an exchange-traded fund and one is an individual corporation. Last but not least, the defensive health care company Abbott Labs (ABT) does not always move in sync with a sector ETF that taps growth-oriented areas like biotech and medical devices.
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. You have to be more strategic; you need to be more targeted in your approach.
Please click this link to discover how “Targeted Asset Allocation” at Pacific Park will help protect and grow your investment dollars!