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Real Investment Diversification

November 10, 2006

Many portfolios of investments that I review for new clients have a common element, if you look at yours, you may see the same thing – lack of real diversification. While most portfolios I see are primarily mutual funds, they are funds from a popular fund company that many brokers use. In most cases the client feels that they are well diversified, and in a low risk position. That is true if one thing happens, that has been going on for a couple of years, the United States and world wide stock markets keep going up. I make this statement because what I often see in these portfolios are a half dozen funds which are all stock based and also an overlapping of stocks. If you look closely, Microsoft, Altria and Google are names that you will see as top holdings of stock in these funds. So how do you know if you are really are diversified with the stock holdings of your funds? The answer is research. You can do this by requesting a current prospectus from the fund company. This prospectus will list the recent holdings of the fund. The best way to request this prospectus is to call the customer service number on your statement. As a customer, they are obligated to send this to you. Another option might be to check the funds website and again request the prospectus. Once you have this information you can then create a spreadsheet of the stocks inside the fund and track the overlap or same stocks in different funds. It will likely be apparent that there is a good deal of sameness in the funds.

If you go through this exercise and find a lot of overlap, you may contemplate what to do next. It is difficult to stay inside one fund family and achieve real diversification, based on my research, because you will probably encounter stock overlap scenarios. To really have a true diversified portfolio, you must be in different asset classes. Asset classes would be stocks and bonds from all over the world, real estate, precious metals, energy, emerging markets, foreign currency and on and on. To achieve diversification, sometimes it is prudent to use exchange traded funds (ETF’s) that take short positions (make $ when going down) in the markets, to possibly hedge your existing positions. That is one reason why ETF’s are so appealing to a portfolio manager, along with the low fees. To see some of the hundreds of choices in ETF’s go to www.etfconnect.com, and explore the possibility of real diversification in your investment portfolio.

It is a popular proven portfolio theory which states; a portfolio of investments which are truly diverse and have little correlation to each other, will give better performance and less risk over a period of time. What that means is to use varied asset classes in your portfolio, that are not alike or correlated because some will be up and some may be down, but at least they shouldn’t be all down, unless of course you are gambling on one asset class, such as stocks or stock mutual funds.