Seeking Diversification
You can knit together a diversified portfolio of investments.
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Putting part of your
principal into equities, part into fixed-income investments, and perhaps
part into cash is only the first step in creating an investment portfolio.
Next, you'll need to decide among individual investments, separate account funds within variable annuities, mutual funds,
or exchange traded funds (ETFs) within those asset classes in order to diversify the portfolio. The first step is identifying subclasses of investments within
each of the three asset classes. And if you're including other asset classes,
you'll want to diversify within them as well.
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In a simplified example, even though a separate account fund that invests in
small-company stock and another one that buys large-company stock are both equity
accounts, they are significantly different investments. Each one exposes you
to different levels of risk, changes in value at different rates, and may
prosper in different economic circumstances. So when small-company stocks
are providing stronger returns than large-company stocks, a small-company
fund in a separate account is likely to provide a stronger return than a large-company fund in that separate account, and
vice versa.
If you own each type of separate account in your variable annuity, you're positioned to benefit
from a strong return on at least a portion of your portfolio, no matter
which account is providing it. The same general principle applies to individual
stock and bond investments, to mutual funds, and to ETFs.
THE SEESAW PRINCIPLE Diversification works because, just as the major asset
classes tend to move in opposite directions, so do the subclasses within
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For example, when investors are buying stocks, stocks provide a strong return
and bond returns are likely to be weaker. And when investors get out of
the stock market and buy bonds, bond returns generally strengthen and stock
returns weaken. Similarly, small companies may prosper during a period in
the economic cycle when large companies tend to struggle.
If you keep money invested in a variety of asset subclasses, you can benefit
in two ways. First, you're in a position to profit from strong returns in
a particular subclass. Second, those gains can help offset losses in a class
or subclass that's slowing down.
USING VARIETY WISELYIf you're seeking diversification in your 401(k) or
similar plan, and the plan offers just a few choices in each asset class,
making decisions is simpler than it might otherwise be. You can carry out
your strategy with the choices you have, and make sure you diversify more
broadly elsewhere in your overall portfolio.
If you have several choices within a single asset class — say
several stock separate account funds — you'll want to look first at each one's investment
objective. Try to avoid investment in several funds that are all making the same
type of investment. To choose among those that invest in similar ways, you'll
want to consider past performance, fees, and a variety of other factors.
While a separate account fund's name is often a useful clue to the kind of investment it
makes, don't take it at face value. Look first at the prospectus
for its official statement, and then check to see if the fund is classified
by research companies, including Standard & Poor's, Lipper, Inc., and Morningstar.
You may find that a separate account fund that describes itself as a small-company account actually
has substantial investments in medium- and large-sized companies. That could
mean you're not as diversified as you'd like to be, and may need to look
at other alternatives. |
LOOKING FURTHER AFIELDInternational investments, especially equities, are also
an important part of diversification. Because the world's economies respond primarily
to events and conditions in their homelands or regions, investing abroad is a way
to build a broad-based portfolio. And the opportunity to invest in emerging as well
as developed markets offers a further level of diversification.
While international investing provides diversification
simply by raising the number of potential investment choices, it also
adds diversity by spreading your investments across different regions
of the world. For example, putting money into a European fund or an
Asian fund can position you to benefit from potential strength in
those areas during periods when the US economy is sluggish or in recession or when the value of the dollar is low.
In general, variable annuities, mutual funds, and ETFs provide the simplest way to invest internationally,
since they handle all of the currency and taxation issues that go
along with buying and selling abroad. But you may also consider American
Depositary Shares (ADSs) issued for the US market by companies based abroad. And many
US companies realize a substantial portion of their revenue from overseas
markets, so they may add an element of international investment to
your portfolio.
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© 2008 by Lightbulb Press, Inc.
All Rights Reserved.
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