More on Diversification in an Outlier Year

After yesterday’s look at an article on supposedly failed diversification from the NYT I found another one from Reuters. The Reuters post was very similar to the NYT article.

One thing that I did not mention is that 2008 (and for however long it lasts beyond 2008) has been the year that is the outlier for everything. It has been the outcome that would be the least probable scenario in any sort of financial planning process.

With that sentiment I am not commenting on whether it should have happened, whose fault it is, the fixes gone bad, what I think will happen next or anything else just the simple idea that down 40%, 30-40% below the 200 DMA for broad market indexes, the implosion in oil, the possibility that the fixed income market is worse off than equities, that commodities have also imploded and anything I am forgetting have created a cocktail of 100 year floods in every asset class (including the bizarre rally in treasuries; TYX as at 3.11!).

2008 was the year no asset allocation model would ever realistically account for. The odds that a diversified portfolio that took no defensive action would stand up to this onslaught were close to nil.

Some of my recent posts have explored ways to possibly construct a different type of portfolio that would mean a different type of market participation and a different type of result. The reason anyone would consider this is if they simply find they cannot stomach normal stock market behavior. However the assumption that the capital markets and the sorts of inter-assets relationships that have existed for decades are now permanently defunct is a bad bet.

This is a disruption of normal market function, without getting into how long it might last for now, that is what it is. I still think normal stock market participation, with some sort of defensive strategy, is the best way to go. I can envision a scenario where a lot of people one way or another give up on stocks, then maybe we end up having a decent cyclical bull market and many of the folks who gave come back in just in time for the next cyclical bear.

The explorations of different portfolio methods is interesting and can be a learning tool as I think it stretches out the mind a little bit but above all I would urge (repeat theme here) keeping it simple with a normal-ish portfolio. Defensive action in the manner I’ve described before is simple. There is no need to even worry about magnitude–indeed I was wrong about the bear market’s magnitude (down 50% twice in one decade? really?) but that has not mattered.

To reiterate a point made many times over, it doesn’t matter if every fund or stock you have is down 40%, what matters is not being fully invested in a bunch of funds and stocks that are down 40%.

About Roger Nusbaum 169 Articles

Roger Nusbaum is an Arizona-based financial advisor who builds and manages client portfolios using a mix of individual stocks and ETFs. Roger writes a popular blog, which focuses on risk management, foreign stocks, exchange traded funds, options etc.

Roger has been recognized by many in the investment management industry for his expertise in portfolio management. Roger has been regularly interviewed by the financial press, trade journals, and television news shows. He has also had numerous technical articles published and has been quoted in a number of professional trade journals, newspapers, and consumer finance magazines. He appears frequently on CNBC Asia as a market commentator.

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