Investor Alert
Kirk Spano

July 9, 2015, 10:51 a.m. EDT

Diversification isn’t all it’s cracked up to be

By Kirk Spano

Diversification has become a buzz word used by financial salespeople to sell things. They like diversification because it helps them sell more products to you. That is a dirty little secret your financial planner won't tell you.

In reality, it's not just financial salespeople who don't use diversification correctly, it's almost everybody. So, shots at brokers aside, this is more about what will keep you safe. Owning a lot of assets isn't it.

While indexers will claim safety, they're wrong. They are taking exactly average risk. Why is that? They own almost everything. That's pretty much the definition of average risk.

Sure, Warren Buffett tells a lot of people to index. He also says this: ""Diversification is protection against ignorance. It makes little sense if you know what you are doing."

What he's really saying is a lot of you aren't qualified to invest. I think, unfortunately, that's probably true. So, index away, just understand the swings you are going to endure, don't sell after big losses, and know that your retirement will not be as secure as you want it to be (when interest rates go up, and they will someday regardless of the central banks, your bond funds will get crushed).

Here comes volatility

With volatility starting to emerge again because of Greece, China, ISIS, Russia, debt, derivatives, demographics, whatever, I suggest you think about your risk right now. I've written five columns this year telling people to think about risk. You've had a heads up from me and dozens of billionaires (I wish I were one of them). At the least, listen to the billionaires.

Yes, I have some attitude right now. Why? Because I have read so many things that have led the little guy to the edge of the cliff. I'm pretty sure the little guy is about to get it again. I'm from a little-guy family, in a little-guy town, in a little-guy state. I hate when the little guy gets jammed. Yet, despite my yammering on, it's probably going to happen again.

Sell something that's over-diversified and hold the cash

If you are a mutual-fund investor, haven't reduced your risk lately and own a lot of stock mutual funds, sell an equity fund or two. Sell any high-yield bond fund you have too. Increase your cash on hand. That is the absolute easiest way to reduce risk.

With many markets being overvalued in general, America's in particular, and many economic risks starting to manifest, carrying more cash makes a lot of sense.

How much cash you carry is an individual thing, but I think 25% to 50% is about right for most people. More cash if you are older. Less if you are younger. More if you don't like risk. More if you like to be an opportunistic or enterprising investor. It doesn't make sense to sell all of your stocks, you never know, the central banks might print money and cause inflation.

Carry more cash in your retirement plans or investment accounts. You will instantly be safer. You will earn less if stocks go up, but you'll also lose less if stocks go down. For most people that is a good trade off.

Raising cash in times like today's is pretty much an asset-allocation idea straight from Ben Graham's book Intelligent Investor (Ben Graham helped train Warren Buffett). In essence, Graham suggested selling some stocks late in a bull market to reduce risk. Not a bad idea. I categorically guarantee you, and remember, I'm in a business where I can't do that, we are much closer to the end of the bull market in stocks than the beginning. If I'm wrong, I'll become an insurance salesman, or maybe solar salesman, or maybe a farmer — better job security in those last two.

What to do with the cash?

Well, there are two things I'd recommend. First, hold onto it for a while. At some point, you will be able to buy back the exact same funds at a cheaper price than today most likely. It might be a year from now, it might be two or three. But it's highly likely that you see an actual correction again someday.

I'll stop to make one Greece comment here: Greece is not a big deal itself in global economics. What is a big deal is that the world cannot even deal with the debt of a little nation. What happens when we have to deal with a big nation's inability to pay back debt? There are a lot of them that is going to happen to soon.

Remember to write down, or email yourself, or use an app or something, what you sold your assets for and what the level of the stock indexes were on the day(s) you did it. Then, as we move 5% lower, then 10% lower, and probably even lower someday, slowly buy equities again. Don't try to be too perfect. Just be better than you would have been. Slow-handed trading works. Even if your returns end up about the same, you were still safer for holding extra cash for a while. And you never know, you might find a piece of land that you'd like to buy in the meantime and get a good price on it. That can be a good investment too done right.

The other thing you could do is look for undervalued stock market assets. Remember, different pieces of the market move at different times. My last column three weeks ago told people they were about to get a great opportunity to buy natural-gas stocks . That index is down over 10% in the last few weeks. It was down about 60% the prior year. A lot of natural-gas stocks are cheap. You don't get these low-risk opportunities with upside very often. Buy a few natural-gas stocks. Inch in. Don't use all your money, just some. That's a great asset allocation and investment move.

Disclosure: Kirk and certain clients of Bluemound Asset Management own shares of FCG and CHK. Kirk has recommended FCG and CHK to subscribers of his investment letter Fundamental Trends. Neither Kirk nor Bluemound clients plan any transactions in the next three trading days. Opinions subject to change at any time without notice.

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