Investment News: Diversification and Asset Allocation

Investing can sometimes feel like navigating a complex maze of terms, strategies, and market movements. As financial planners, we strive to help clients stay on course, even during periods of market volatility. In this article, we’ll discuss two important concepts for long-term financial planning: diversification and asset allocation. We’ll also explore broader investment strategies beyond traditional stocks and bonds.

The goal here is to create a timeless framework that helps investors build robust portfolios, better prepared to weather market turbulence.

Diversification vs. Asset Allocation: What’s the Difference?

When discussing investment strategies, the terms “diversification” and “asset allocation” often come up. But while they’re related, these two concepts aren’t the same, and understanding the difference can significantly impact your financial planning decisions.

Asset allocation generally refers to the balance between stocks and bonds in a portfolio. How much you allocate to each depends on your risk tolerance, investment goals, and time horizon. A conservative investor may favor more bonds, while a more aggressive investor may lean heavily toward stocks. Within each asset class, you can further refine the strategy—stocks can include small-cap, mid-cap, large-cap, international, or sector-specific investments. On the bond side, you might consider various durations, like short-term, intermediate, and long-term bonds, as well as different types, such as government, corporate, and municipal bonds.

While diversification can seem similar, it actually goes beyond merely balancing stocks and bonds. Diversification is about spreading your investments across multiple risk categories. It’s the principle of not putting all your eggs in one basket—but that doesn’t just mean holding different stocks and bonds. A truly diversified portfolio can include a broader range of asset types, such as Certificates of Deposit (CDs), fixed and fixed index annuities, real estate, rental properties, small business ventures, collectibles, or even an Airbnb investment. The idea is to reduce overall risk by investing in various asset types that may not all react the same way to market events.

By incorporating different types of assets, diversification aims to protect your portfolio from volatility, particularly when one sector, like stocks or bonds, may experience a downturn. It’s a more comprehensive way of spreading risk, as different asset classes are affected by economic conditions in different ways.

How 2022 Challenged Conventional Wisdom

One of the cornerstones of traditional asset allocation is that stocks and bonds often move in opposite directions. When stocks are performing poorly, bonds typically provide stability, and vice versa. This concept was turned on its head in 2022 when both sectors posted negative returns, leaving many investors scratching their heads.

Historically, the last time stocks and bonds both declined in the same year was 1969, and before that, 1931 during the Great Depression. The events of 2022 were a rare anomaly, driven by a series of unusual economic and geopolitical events. We were still recovering from the economic fallout of the pandemic, coupled with the impact of the Russian invasion of Ukraine, and the Federal Reserve’s rapid increase in interest rates to combat inflation. This perfect storm created a scenario where both stocks and bonds suffered simultaneously.

While unusual, this scenario underscored the importance of sticking with a well-diversified portfolio. Even in the face of temporary downturns, history shows that balanced, diversified portfolios tend to recover, and those who stay the course are often rewarded with long-term gains.

The Importance of Staying the Course

Market corrections, like the one experienced in 2022, can be unsettling. It’s natural to feel anxious when you see both your stock and bond holdings losing value at the same time. However, one of the worst mistakes an investor can make is reacting emotionally to short-term market movements by selling off assets in a panic.

The beauty of diversification and asset allocation is that they are designed for the long term. When one part of your portfolio struggles, other parts should help stabilize your overall performance. In 2022, while both stocks and bonds dipped, those who held a diverse array of other assets—such as real estate, annuities, or other alternatives—likely fared better.

It’s also important to remember that even during challenging periods, markets tend to rebound over time. Already, we are seeing signs of recovery, and those who stayed the course are beginning to see their portfolios recover from the volatility of 2022.

Schwab and TD Ameritrade Merger: What to Expect

A significant change in the financial industry is the merger of Schwab and TD Ameritrade, two of the largest brokerage firms. For those of you who use either platform, you might be wondering how this merger will affect you.

First and foremost, both companies are working to ensure a smooth transition. If you’re a current client of TD Ameritrade, your accounts will gradually be moved over to Schwab’s platform. Expect communication from both firms detailing any action required on your part, although the process is designed to be as seamless as possible. Schwab’s robust technology and user-friendly interface should enhance the overall experience for TD Ameritrade clients, and they are focused on preserving the quality service and competitive pricing both firms are known for.

For investors, this merger will likely lead to improved access to tools, research, and resources. Schwab’s platform offers a wide range of financial products, educational content, and retirement planning tools, which should benefit all clients, regardless of which platform they started on.

Final Thoughts

A well-constructed financial plan is like a sturdy ship that can weather storms—market corrections, economic downturns, and global events like we saw in 2022 are part of the journey. Diversification and asset allocation remain critical tools for managing risk and achieving long-term financial goals. Even in the face of unprecedented events, a diversified, well-balanced portfolio will help you stay on course.

The key takeaway? Stay calm, stay the course, and remember that history shows those who take a disciplined approach to investing often come out ahead in the long run.