Focus on finance: Diversify among different asset types for stability, growth

Question: How important is diversifying my portfolio?

Answer: Growing wealth for our financial security is a key responsibility in life. As we approach and begin our retirement years, we replace our reliance on job earnings with the earnings of what we’ve accumulated. Recognizing why we should allocate our wealth among different asset types is essential to maintaining our financial security.

Important asset types are Equities, Debt, Real Estate, Gold and Cash

• Equities represent ownership in companies in the form of stocks. They can appreciate or depreciate in value.
• Debt represents loans from companies or municipalities. They generate interest and return principal at maturity.
• Real estate represents ownership in buildings and land (which they’re not making any more of). It can depreciate but over the long run generally appreciates. Rental real estate generates income. Real estate often requires a significant investment to purchase and the ability to borrow.
•  Gold has value since there’s relatively little of it and people find comfort in owning it as a safe store of value in uncertain times for future conversion to something else.
• Cash represents the most liquid of holdings. It generates little earning but allows for ready purchases without jeopardizing profits in other, less liquid assets.

Aside from their intrinsic value, not all assets move in the same direction at the same time under changing market conditions. In fact, it’s rare if they do. Some exhibit cycles or ups and downs over time.

If stock markets are witnessing a prolonged rally, then it’s unlikely that other assets like gold and property will also witness a sharp upturn at the same. Likewise, if stock markets are in the midst of a prolonged bear phase, other assets are unlikely to be in the same situation.

For instance inflation which can be a negative for stocks in the short-term can lead to a rise in gold prices or real estate as investors move from currency denominated assets to ‘real’ assets. On the other hand a rise in interest rates can lower real estate values while gold remains high.

Since you don’t know which asset will be favored at any particular point of time, its best to diversify your asset-types to improve your chances of achieving your long-term goals with a minimum of negative fluctuation in your overall portfolio. That way a decline in any one asset type can be partially offset by other assets types not undergoing the same trend. Diversification and asset allocation do not guarantee a profit, nor do they eliminate the risk of loss of principal. Additionally, it must be clear that all investing involves risk, including the loss of principal.

Wm. Steve Wright is themanaging member of The Wright Legacy Group LLC.