The Benefits of Diversified Wealth Management Strategies

By : Jeremy Sorci | September 12, 2020

Long before the days of investment management solutions, financial derivatives and modern portfolio theory, Sancho Panza — Don Quixote’s sidekick – wisely noted, “It is the part of a wise man to keep himself today for tomorrow and not to venture all his eggs in one basket.” Of course, Don didn’t take this sage advice – but you should.

Diversified wealth management is more complicated than many would think. Our clients often ask us how to diversify; while they understand the basic importance of not putting all of those eggs in the same basket, they’re just not sure how to go about it in the most effective manner. Here’s how to avoid diversification pitfalls and create a blueprint to evaluate your own portfolio.

The ‘D’ Word and Financial Strategies

First, the basics: diversified wealth management is, at its core, a risk management technique. A diversified investment portfolio balances funds among securities from different industries or different classes, based on the premise that a portfolio of differing investments will, on average, produce better risk-adjusted returns and less volatility than its individual components.

Sounds simple, right? Here’s where it gets a bit complicated.

Concentration is Not an Asset Management Solution

While few would argue against the necessity of diversification to the success of long-term investors, ideas abound – and vary widely — about what constitutes a diversified portfolio. Further muddying the waters, there’s also an overwhelming amount of misinformation about diversification floating around.

In our investment firm’s worldview (which, unfortunately, differs from the mainstream due to the successful and misleading marketing techniques of the financial services industry), diversification means to fundamentally own everything. According to the evidence-based research of Dimensional Fund Advisors, the institutional asset class fund provider to whom our clients’ investment dollars are allocated, a truly diversified portfolio consists of many thousands of individual securities.

We practice what we preach; our client portfolios consist of a global basket of over 9,000 stocks, all but eliminating company-specific and sector risks that have caused — and continue to cause — investors so much pain. And if you don’t believe that owning concentrated positions in individual companies is dangerous, simply consider the case of AIG, GM and many of the national, regional, or local bank stocks.

Your Investment Professional may be misinformed

But, regardless of our worldview, misleading information about diversification is rampant. Many so-called financial experts, investment professionals, and publications simply have it wrong.

Consider the “Am I Diversified” segment on CNBC’s “Mad Money,” where investors call in to have their portfolio diversity evaluated. In most cases, the host gives portfolios with as few as five stocks a passing grade! Such a concentrated portfolio should never be considered diversified; promoting the idea that owning a handful of securities is “diversified” is both misinformed and foolish.

In another example, a popular investment education site states that, “a well-diversified portfolio of 25 to 30 stocks will yield the most cost-effective level of risk reduction.” Really? Currently, investors can purchase low-cost, highly diversified index or asset class funds containing thousands of individual securities. Why would any investor own a concentrated portfolio when they could own a diversified portfolio of stocks at minimal cost?

These types of misinformation link to a lack of investment success.

Why Diversification Matters to Your Comprehensive Financial Plan

Bruce Smith is a 401(k) Financial Advisor with Premier Financial Group in Eureka Humboldt County

Diversified wealth management strategies (or the lack thereof) have serious implications for portfolio performance. These strategies could even be the deciding factor on whether or not you meet your long-term financial goals. Sound like hyperbole?

Not when you consider that, on average, individual investors significantly underperform as compared to market rates of return. Dalbar’s 2013 Analysis of Investor Behavior found that an average mutual fund investor underperformed the S&P 500 by a whopping 48% over a 20 year period ending in 2012.

Recommended Investment Management Solutions and Actions

Given the importance of diversification to your long-term investment success, we recommend that you:

  • Review your most recent account statement; an under-diversified portfolio has a list of individual stocks and bonds or a handful of mutual funds
  • Ask your advisor to explain their beliefs about diversification; if the answer is anything other than owning everything, you should be very concerned.
  • Seek the advice of an independent Registered Investment Advisor (RIA) or CERTIFIED FINANCIAL PLANNER TM regarding diversifying your portfolio.
  • Work with a RIA that manages assets through indexed portfolios or structured asset class investing.

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