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Diversification Does Not Guarantee Safety

The best us of diversification is to spread your money around to different types of investments to reduce your risk.

Diversification is a sound investment principle. I would say that every Illinois investor at one time or another has heard or read something about the benefits of a diversified investment account.

“Don’t put all your eggs in one basket” is about all you need to remember about diversification.

The best use of diversification is to spread your money around into different types of investments in order to reduce your risk. This investment management strategy is easily accomplished today due to the wide variety of investment options available to every size of investor in every type of investment account.

The important thing to remember is that diversification does not eliminate risk.

International stocks were once hailed as a way to diversify away from exposure to the U.S. economy. Several years ago, the main international stock markets were not closely related to the direction of either the U.S. economy or the U.S. stock markets. Today, that is no longer true.

International stock markets are all interrelated; they rise and fall together most times. That fact was clearly demonstrated during the most recent stock market crash in 2008-2009.

The lesson is that diversification might help smooth out routine stock market fluctuations, but under extreme conditions your stock market risk level is likely to rise and fall at the same time regardless of your diversification efforts.

Most financial advisors make the case for individual investors to diversify their investments and to place them on auto-pilot. The thinking is that if your investment assets are properly diversified, your long-term investment returns will be acceptable over the long term.

From February 1, 2000 to February 1, 2013, the total investment return of the S&P 500 was 7.31%. If you would have placed the same amount of money in a money market account, your investment return would have been close to 30% over the same time period.

Neither of those investment returns over a period of 13 years is acceptable. Food,gas, rent, and college tuition have all risen much more than 30% over the last 13 years.

Diversification of your investment assets is not the only investment management strategy solution. Managing the stock market risk on your investments is a lot more important than diversification.

Ed Downey
Downey Financial Group

This post is contributed by a community member. The views expressed in this blog are those of the author and do not necessarily reflect those of Patch Media Corporation. Everyone is welcome to submit a post to Patch. If you'd like to post a blog, go here to get started.

Gregg Slapak March 06, 2013 at 04:43 AM
So, Ed how's business going for you.?
Dan Wilhelm March 06, 2013 at 05:00 AM
Yes, I am Ed. Run with that.
Jim Hankes March 06, 2013 at 09:47 AM
Ed, thanks for the informative and factual information. Having just heard two commercials on the importance of diversification, your post provides good food for thought.
RB March 07, 2013 at 12:36 PM
Wow. This can only hurt business for Providence Bank and Mike Gresk.
Sean Johnders March 07, 2013 at 12:42 PM
RB, you nailed that one!

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