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Thursday, October 26, 2017

Fill your investment basket with a 
variety of assets to reduce overall risk

Photo: William Potter/iStock

By Rick Rodgers
Guest Columnist

Diversification, which is the process of spreading assets in a portfolio across several different asset classes (investment strategies), is a key to managing risk and helping your money grow over time. The Periodic Table of Investment Returns, below, illustrates the benefits of diversification.

The table above shows the performance rankings of several asset classes for each of the past 10 calendar years. Each asset class is represented by a unique colored box that contains the asset class name and the total annual return for the correlating year. The best performing asset class for each year is ranked in the top row, while the worst performing is listed on the bottom row. In a perfect world, investors would somehow know in advance which asset class will perform the best and allocate to those assets, capturing the largest returns each year. However, in our imperfect world of investing, we are unable to know or consistently predict this information.

Choose an asset class listed in the first column (the calendar year 2007) and follow its return for each of the next nine calendar years. For example, International Stocks was the second-best performing asset class in 2007, with a total annual return of 11.17 percent, a nice return. However, the following year, which was difficult for nearly all asset classes, International Stocks was the worst performing asset class, losing more than 40 percent of its value. As you follow the performance of International Stocks through the remaining calendar years you’ll notice that it moves all over the table. This example illustrates how difficult it is to predict investment performance of a single asset class from year to year.

One of the most common mistakes of individual investors is attempting to choose an investment, or investments, this year based on performance last year or in the past few years. This approach is referred to as “rearview mirror investing” or “chasing past performance.” The investor’s objective is a misguided attempt to increase returns by investing only in what appears to be hot at the time. The problem with this approach is the evaluation of the investment comes after it has already performed well, and the investor believes that the hot streak will somehow continue. While some asset classes may be the best or worst for two or more consecutive years, it is impossible to predict when the streak will begin and how long it will last. 

Markets are cyclical and impossible to accurately predict from year to year. Therefore, a more prudent approach would be to maintain a diversified portfolio, which is illustrated in the “black” boxes in the Periodic Table of Investment Returns. The Diversified Portfolio is never ranked at the top or the bottom of the table. It will never be the best or worst performing, whereas a single asset class may be the best or worst performing investment for a single year or multiple years.

Another benefit of diversification is the ability to manage risk in the portfolio. The two columns on the far right of the table rank the annualized performance (average annual performance for each of the 10 years shown) and risk. You will notice the performance ranking of the Diversified Portfolio is near the middle of the group, while the risk is ranked much lower. The message of the Periodic Table is that diversification can help manage risk and create more consistent returns over the long term. 

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of Innovest or TEXPERS.

Rick Rodgers
About the Author:
Rodgers is a principal and director at Innovest Portfolio Solutions. He is a member of Innovest’s Retirement Plan Practice Group, a specialized team that identifies best practices and implements process improvements to maximize efficiencies for our retirement plan clients. In September 2014, Innovest was named the Retirement Plan Adviser Team of the Year in the nation by PLANSPONSOR. Rodgers has more than 27 years of experience working as a consultant and educator to public and private-sector retirement plans. Prior to Innovest, Rodgers was co-founder and CEO of InSight Employee Benefit Communications, which merged with Innovest in 2014. He also served as director of marketing and client services for the Colorado County Officials and Employees Retirement Association.  He was formerly a managing area director with Nationwide Retirement Solutions and worked with the state of Florida Deferred Compensation Program prior to relocating to Colorado in 1991.  He has earned the Accredited Investment Fiduciary and Accredited Investment Fiduciary Analyst designations from the University of Pittsburgh, Joseph M. Katz Graduate School of Business, and has received formal training in investment fiduciary responsibility assessment. Also, he has earned the Series 65 License (Registered Investment Adviser Representative) through FINRA. He is a member of the National Association of Government Defined Contribution Administrators, California Society of Municipal Finance Officers, Society of Human Resource Managers, and currently serves as Chairman of the Board for the Colorado Public Pension Coalition.

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