Is Diversification Dead?

With investors feeling lost and desperate after the second worst year in the history of the stock market, many have changed the way that they manage their investments in order to avoid another painful year like 2008. It was a market that took no prisoners, with neither stocks nor bonds providing a place to hide. Unless you were in cash or Treasury Bills, you probably sustained massive losses.

Investors have reacted in several ways to these losses, but most are currently evaluating their investment portfolios and rethinking their strategies. One of the core principles of investing has always been to diversify. It’s a simple concept that helps you to avoid having all of your eggs in one basket. If you would have had all of your money invested in Bear Stearns or Lehman Brothers, for instance, last year would have been ever more painful.

Diversification is a strategy that has proven to work well for investors over time, but many investors are abandoning sound investment principles after losing faith in the financial markets last year. This irrational behavior can manifest itself in a number of ways.

Some investors have left the market completely, selling their investments and even halting contributions to retirement plans. This may help you sleep at night now, but it will make it difficult for you to achieve your future financial goals. Other investors have moved in the opposite extreme direction, taking on unreasonable risk in their portfolios to make up for the losses of last year. Neither of these strategies is likely to be a wise long term investment decision.

The way you invest depends on several factors, but diversification is one of the underlying core principles of successful investing. Regardless of your mix of stocks, bonds, and cash, spreading your risk among several asset classes and individual investments will continue to be your best bet as an investor. Last year’s investment results were an extreme outlier when compared to just about any other year over the past century. To change your entire investment strategy based on one dismal year in the market could be a very costly decision, but it is one that many investors are making.

Now is a great time to rebalance your investment portfolio and make sure you’re properly positioned to take part in the recovery of the stock market, whenever it occurs. The same principles that have made you successful as an investor in the past are the ones that you should live by with your future investments, even after a very difficult 2008.

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