Asset Management: Investing in a Diverse World

The household net worth of American families fell by 4.7 percent in the fourth quarter of 2008, resulting in a loss of $2.81 trillion, according to the Federal …

The household net worth of American families fell by 4.7 percent in the fourth quarter of 2008, resulting in a loss of $2.81 trillion, according to the Federal Reserve’s Flow of Funds report. The fall-out from the ailing credit, stock and housing markets has many Americans asking themselves tough and scary questions: When will the recession end? What’s going to happen to my home? Will I be able to retire? What am I supposed to invest in now?

Though none of these questions have clear-cut answers, there are some pieces of tried-and-true advice for investing during such volatile times. At the center of these strategies is diversification, a method that financial experts like Michelle Davidson, managing director at PCG Asset Mangement, say is absolutely vital to minimizing risk and emerging from a down market relatively unscathed.

“People often do two things when experiencing a truly negative market,” Davidson said. “They do nothing, or they panic, sell everything and invest in something different.”

Most investors find neither option attractive. Leaving money in an investment with a downward trajectory can seem counterintuitive to most financial goals, and jumping on the next big trend can be foolish if that investment vehicle is not completely understood. To investors trying to weather this downturn, financial experts advise diversifying into neighboring investments, keeping fear in check and rationale in control.

Don’t try to predict the future…

Even when values rise steadily for years at a time—as was the case in the housing market—most people will not be able to time their exit from the market exactly right. Accepting that neither the market nor human intuition are perfect empowers investors to move on from what they cannot predict or control and onto what they can. Something that Davidson believes is easy to control is the level of diversity within one’s portfolio.

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The most common ways to ensure that your portfolio is diverse is to examine what types of assets you are investing in, what geographical regions these investments reside in and how many industries or markets these investments fall under.

One of the easiest ways to diversify your assets is to invest in both the stock and real estate markets. These markets are fairly independent of each other and profits gained in one can mitigate or overcome the losses experienced in another. Local, national and international economies ebb and flow, so spreading your investments geographically is also smart. As Orange County, Silicon Valley and Detroit can all attest, boom periods rarely last. All three experienced booming economic times that when their respective industries were in high demand. However, when the mortgage, dot-com and auto industries faltered, so too did their economies, and on multiple levels. Apropos to market sectors, the bailout debate raging today has proved beyond a doubt why it is never wise to invest exclusively in cars, homes, insurance, banks or any other other industries that have fallaciously been considered “too big to fail.”

In terms of private equity, Davidson believes that emerging international markets, such as China, hold many opportunities. She noted, however, that even within emerging markets there’s room for diversification. “[Look] not just at China,” she said. “Take a more diversified approach to Asia as a whole.”
…do think long-term

No investment is safe from losses and depreciation, and everyone is almost certain to lose money now and again. Knowing this should deter most investors from moving all of their money into a different investment just because there is a blip in the market. Instead of acting out of fear, advisors suggest that anyone worried about their current holdings or suspicious of some potential dealings should do their homework.

“Look at the investment, at how much transparency it has,” Davidson said. “This can be particularly easy if the investment is publicly traded.” Even if it’s not publicly traded, investors can still comb news archives to uncover any publicly reported bouts of corruption, changes in management or financial troubles.

One can also research an investment vehicle in general, noting how similar assets, assets in the same region and assets in the same market sector have performed over time. Be sure to note any particular conditions—whether directly or indirectly linked to the investment—that might affect its performance. These could range from a nationwide housing boom to a terrorist attack, upcoming holiday season or emergence of a new trend. Charting an investment vehicle’s path can help you predict how it may respond to future market conditions, allowing you to determine whether it is a viable opportunity for you.

Tread carefully in new waters

Regardless of how great an investment opportunity sounds or how much you want to diversify, experts agree that it is never a good idea to invest in something you do not completely understand. If a financial advisor cannot succinctly explain an investment opportunity to the point that you understand your level of risk, exit strategy, and how any potential fees or profits accumulate, then that opportunity is probably not right for you.

“If you’re not familiar with an asset, do not jump into it,” Davidson said. “You can make subtle shifts in your investments, but don’t go head-first into [alternative investments like] gold.”

This doesn’t mean that you should never move into new territory simply because you don’t know every facet of the investment. It simply means that you must conduct your own due diligence and spend the appropriate amount of time with your advisor, who should be experienced in that investment vehicle.

A down market may also provide the perfect opportunity to explore investments that have a structure similar to one’s with which you are already familiar. An office landlord could easily understand the pros and cons of renting out a vacation home; a REIT investor likely has a lot in common with a TIC investor; and many issues that affect the London Stock Exchange also affect the Irish Stock Exchange.

Diversifying your investment portfolio can seem a bit like placing bets on a roulette wheel—the more numbers you pick the more likely it is that you’ll come out a winner. However, just as in roulette, there comes a point where the payout is smaller than the amount of money you spent betting on so many numbers. To avoid this blind-betting strategy, be sure to do your homework, learn about any desired investment vehicles and align yourself with advisors who have your best interest at heart.

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