Diversified portfolios allow for ‘smoother ride’
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Key takeaways:
- By maintaining a diversified asset allocation, windfalls can be invested without fear.
- A diversified portfolio is not dependent on luck, the success of a single stock or the success of a single asset class.
Why not just invest in one stock and let it ride? That works well if you bet the farm on Apple in 2010 and watched your fortune explode 30 time during the last 14 years.
But if your solitary holding was Kraft Heinz in 2015, your portfolio would only be worth about a third today — even less when you consider inflation, despite America’s love for cheese and ketchup.
A diversified portfolio allows for a smoother ride that is not dependent on luck, the success of a single stock or the success of a single asset class. For most physicians, slow and steady will win. At the start of one’s career, with a longer investment time horizon, one’s asset allocation can be more aggressive, tilted toward stocks. However, as one’s portfolio grows and retirement approaches, it is important to consider becoming more conservative — for instance with bonds — and focus on wealth preservation rather than aggressive growth.
Finally, if one maintains a diversified asset allocation with his or her investment time horizon in mind, windfalls can be invested without fear into that same diversified allocation at any time.
A balanced portfolio is diversified over three fronts:
Asset classes: There are many asset classes, including stocks, bonds, cash, real estate, commodities, cryptocurrency, private equity and other alternative investments. For most of us, we only need two asset classes: stocks and bonds. Holding a total stock market index fund is an excellent way to diversify your equity holdings, as you own the entire market. For most of us, maintaining a simple two-fund portfolio of a stock index fund and a bond fund is more than sufficient asset diversification. All that one needs to adjust is the balance between the two. In our 20s, we might be 100% stocks and 0% bonds. This balance might gradually shift to 40% stocks and 60% bonds by retirement age.
It is important to periodically rebalance if one asset class is skyrocketing, tilting back to your predetermined balance between stocks and bonds. In principle, rebalancing forces one to sell high and buy low. However, given most of your portfolio will be in taxable accounts, the reality is that most of us will rebalance the overall portfolio by disproportionately investing a greater percentage of our regular investments into the lagging asset class. If we want to maintain an 80:20 stock to bond ratio, and your bonds are lagging, allocate most of your monthly investments into bonds.
One final note is that there are many other intriguing asset classes, such as real estate, that can help round out a diversified portfolio for those with the time and interest in learning about them, and who are not afraid to carry a slightly more complex portfolio.
Markets: There can be value in diversifying between domestic and international markets and holding both a total U.S. stock market index fund and an international stock fund. However, we would point out that 42.5% of the total U.S. stock market is comprised of global equities (think of all the multinational companies in the United States like Google, Microsoft, Walmart, Proctor and Gamble, etc.), and if you want to keep it simple, just own a total U.S. stock market index fund to cover domestic and international markets. If you are comfortable with some complexity and additional diversity, consider an international stock fund.
Time: We might not think of time as a diversifier, but when one invests periodically over time into their predetermined asset allocation, he or she is buying more when the market is down and less when the market is up. This so-called dollar cost averaging helps to reduce volatility and can be automated via a direct linkage between one’s checking and brokerage accounts with instructions to invest at a predetermined interval.
For more information:
Chirag P. Shah, MD, MPH, is a soccer and Nordic ski coach, who also practices medicine and teaches in Boston. He can be reached at cshah@post.harvard.edu.
Jayanth Sridhar, MD, is an award-winning podcaster, physician and educator who is chief of ophthalmology at Olive View Medical Center in Los Angeles. He can be reached at jsridhar119@gmail.com.
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