For years, financial advisers have preached the wisdom of a diversified portfolio, weighted between stocks and bonds according to age and risk appetite. But after experiencing the 2008-2009 financial crisis, when nearly all financial markets fell in unison, some investors question that notion.
Investing in the new economy
Nonetheless, most experts still believe in the idea. “Diversification does work, but it doesn’t solve all your problems,” says Charles Lieberman, chief investment officer of Advisors Capital Management in Hasbrouck Heights, N.J.
Even during the financial crisis, some assets gained in value, including Treasury bonds and the dollar. Mick Heyman, an independent financial adviser in San Diego, recommends a mix of conservative blue chip stocks, Treasuries and a small amount of gold.
By following that strategy, his clients’ losses in 2008 ranged from 5 percent for the most conservative investor to 20 percent for the most aggressive, compared to a 37 percent drop for the Standard & Poor’s 500 index.
“I believe one lesson from the crisis is that diversification won out,” Heyman says.
Subject to interpretation
Financial advisers define diversification very differently.
Louis Stanasolovich, president of Legend Financial Advisors in Pittsburgh, recommends that clients devote some money to managed futures, an investment fund that uses futures and options to go long or short in virtually any asset class.
The average managed futures limited partnership gained 26 percent in 2008, Stanasolovich says. These limited partnerships are generally available only to wealthy investors with minimum investment assets of $1 million. But now there are several managed futures mutual funds. While most of them began after the financial crisis, at least one rose during 2008: Rydex/SGI Managed Futures Strategy Fund gained 8.53 percent that year, compared to the market’s 37 percent loss.
“Diversification does still work, but it works in a manner most investors aren’t used to,” Stanasolovich says.
That brings us to the area where experts’ opinions diverge greatly — how to create a diversified portfolio. Stanasolovich and Chris Geczy, director of the Wharton Wealth Management Initiative at the University of Pennsylvania, agree that a diversified portfolio must hold alternative assets. That could include managed futures, real estate, commodities and mutual funds that employ strategies similar to hedge funds.
Noting the old adage that investors should have 60 percent of their assets in stocks and 40 percent in bonds, Geczy says, “The new 60-40 is 60 percent traditional investments (stocks and bonds) and 40 percent really diversified, including alternative assets.”
The university endowment model, which includes a hefty dosage of alternative assets, works better in the long term than a portfolio of just stocks and bonds, Stanasolovich says. But that doesn’t always work. Many university endowments saw their alternative assets plummet in value during the financial crisis.
Stanasolovich also recommends purchasing foreign stocks, foreign bonds of developed and emerging markets countries and foreign currency exposure, which can be gained through exchange-traded funds. “A lot of things would work,” he says.
More conservative approach
Heyman, who takes a more conservative approach, doesn’t see the need for taking on this additional risk. “I’m talking about people who want to save and preserve their money. The other side is people who just want to make money.”
Blue chip stocks provided him and his clients peace of mind during the financial crisis, because apart from some financial services firms, you knew they were going to be around afterward.
The key issue for those using Heyman’s strategy is that “people have to be very sensitive not to cheat on it” by taking more risk in search of a higher return, he says. “People want higher yields than Treasuries provide, so they put themselves at risk.”
In terms of allocation, Heyman recommends anywhere from 30 percent to 80 percent stocks, 5 percent to 10 percent gold, and then the rest in Treasuries and cash. Be honest with yourself about what risk you can tolerate and stick to it, he says.
Stocks, stocks and more stocks
Lieberman has a somewhat unique take on diversification. He thinks it can be achieved through a portfolio of almost exclusively stocks.
“For most of my life, I’ve been 100 percent in equities,” he says. “The more assets people have, the more they can diversify away from single-security risk — therefore, the more equities they should have even if they’re older.”
Lieberman thinks the best way to diversify is to buy stocks across a mix of industries. “That could include autos, manufacturing, some service industries, retailers, financial services,” he says. “That’s the primary way.”
Buying stocks of different-size companies doesn’t “accomplish much” in terms of diversification, he says. Lieberman also sees no need to buy foreign stocks, as you can easily purchase equity in U.S. companies that derive much of their revenue overseas. That way you’re sure to get a stock that trades on a U.S. exchange denominated in dollars.
“To the extent that someone is looking more for income, they would tilt away from growth stocks to mature companies with dividends,” Lieberman says. “Perhaps they’d also have some fixed income. To the extent people want more growth, they’d push in the other direction.”