IMPORTANCE OF DIVERSIFICATION: STRONG LEADERS KNOW BETTER THAN TO PUT ALL THEIR EGGS IN ONE BASKET
WOMEN’S FINANCIAL REALITIES ARE SOBERING
In our first entry, “Taking the Lead: Facing the Financial Realities Unique to Women,” we saw the stark effect of the financial realities that women face. Since women are in a position where, on average they earn less, yet live longer; they must be excellent financial stewards to make sure that they are able to enjoy retirement in good financial standing.
SAVINGS: THE SECRET TO LONG-TERM SECURITY AND CONFIDENCE
Clearly, in order to be excellent leaders, it is vitally important to take care of our own financial houses. In the second installation of the series, we learned the importance of savings and how to get started. We saw how small changes made a big difference and could contribute to our overall confidence and presence. For reference, “How Saving and Investing Your Money Strengthens Your Confidence and Leadership Presence” is available in Part 2.
THE CRUCIAL INVESTMENT DECISION: ASSET ALLOCATION
Once we’d implemented a consistent savings plan, we were ready to invest. We felt more confident, as we learned that the most important decision regarding our investment was the strategic asset allocation—how much we have invested in stocks, bonds and cash. We learned to start there rather than focusing on trendy stock tips that pop up everywhere. You can review this information in, “Asset Allocation: Savvy Investors Know this is the Crucial Investment Decision,” which is also featured in Part 3 of this series.
DIVERSIFICATION: DON’T PUT ALL YOUR EGGS IN ONE BASKET
Let’s say that you start investing and buy a single stock. Yikes! Your entire investment is now exposed to that stock, that industry and nothing else. What if the absolutely worst situation occurs and that company goes bankrupt. Your stock will be worth nothing! You really want to hold investments in groups that have variety across asset type and industry. This way, if one of your holdings goes down, others may go up. This preserves value by keeping you from being completely exposed to all the risk in one single category or company. By doing this, you create a portfolio in which the sum is greater than the parts.
Some investments tend to move up or down in value together. Some investments move independently of each other and others move inversely (when one is up the other is down). While we would all like to own investments that only go up, we know that this is unlikely to occur. However, there is great protection in owning a mix of assets that perform differently from one another. Some assets will increase in value over time, some may decrease in value, but with assets chosen to perform differently from one another, this design may provide some protection against full negative returns. Portfolios that incorporate these differently performing assets tend to have lower volatility than that of an individual asset.
This also teaches an important lesson—you should focus on the performance of your portfolio as a whole, not on the returns of either the winners or the losers. A lot of the investment talk at cocktail parties focuses only on the winners. You have no idea how other people’s overall portfolios are performing. And, it is the overall portfolio return that will determine your long-term wealth.
YOUR BASKET FULL OF STOCKS
So, you plan to diversify. How diversified should you be? The answer is that you should be as diversified as possible. In the area of U.S. stocks, you might want to start with an allocation to the stocks that are included in the S&P 500 Index. These 500 stocks account for about 70% of the market capitalization of the U.S. stock market. Do you have to buy 500 stocks? No! There are funds and investment options that purchase all of these for you when you own that investment vehicle.
Now, once you get started with that, you will also want to own the small capitalization stocks in the U.S. (They are smaller, so there are about 4500 of them! Don’t worry. Once again, you can purchase a fund or investment vehicle that gets you exposure to these securities.)
And, it would be wise to also consider the benefits of diversifying your investment by holding some international stocks too. It is important to consider a broad amount of international exposure including securities from countries with developed markets and securities from countries with emerging markets (developing and growing countries). These groups of stocks behave quite differently from U.S. stocks, so they can add value. As your portfolio grows in size you should invest to include them.
YOUR BASKET FULL OF BONDS
This same type of diversification should also be part of your bond portfolio. You want to own bonds that have a variety of issuers. These include Treasury Bonds (issued by the Federal Government), Government Bonds (issued to support Government agencies) and Corporate Bonds (issued by companies to finance their growth). While Treasury and Government Bonds have very high credit ratings, you may own a range of credit ratings by purchasing a portfolio or fund of corporate bonds. Clearly those credit ratings mean something! So, the savvy investor will favor the bonds or the bond funds with higher quality credit ratings! Don’t gamble your entire portfolio by getting caught up in seeking tiny amounts of additional return from risky investments. These should be a small percentage of your investment portfolio, at most.
The other decision in making a bond investment is the maturity—how long until the bond matures. Bond maturity can be longer (10 years or greater) or shorter (less than 5 years). Bonds with longer maturities are more risky. So, as you construct a portfolio, you may hold bonds with varied maturities, but it will be safer to hold those with shorter maturities.
Again, if you have a portfolio that is large enough, international bonds can also provide excellent diversification. International bond investments are investing in the bonds of foreign governments.
Your ideal portfolio may be composed of 60% stocks and 40% bonds. This is a typical mix and provides a great amount of diversification. But, everyone is different! If you are willing to accept more risk (which equals more volatility—returns that go up further and go down further) you may prefer a portfolio with 80% stocks and 20% bonds. Or, you may be very sensitive to market movements after working hard to save money. It may be well worth it for you to accept a lower return with less volatility and hold 40% in stocks and 60% in bonds. The answer is whatever you feel best about.
But, once you decide, it is important not to invest in a single stock or a single industry. You will get a far more consistent return with fewer plunges if you invest broadly in stocks—owning at least the largest 500 stocks in the U.S.! Then you are protected from the specific news about any single stock. This helps you protect against the downside (a bit) while earning the market return.
LEARNING TO STAY THE COURSE, EVEN IN DIFFICULT TIMES
Now it is time to ask about how to adjust your portfolio over time. It will be important to stay the course and we will tackle that issue in the next entry. Please watch for:
- Women leaders have the confidence to stay the course in investments as well as strategic plans.
- Effective leaders know when and how to delegate: Finding a financial advisor.