John Diehl | Wed Sep 06 10:00:00 EDT 2017
Investors have been reaping the benefits of a sustained bull market for some time now, which may instill in them a false sense of security and lead them to lose sight of risk levels in their portfolios.
While bull markets can be good news, they can also make your clients more susceptible to the hot hand fallacy – a term used to describe the behavior of expecting future results to mimic past results. In other words, since bull markets tend to encourage investor optimism, your clients may expect this upward streak to continue and, in turn, go “all in” with their investments.
Advisors need to help their clients avoid getting carried away by the long-running bull market by instead using it as an opportunity to help build understanding around why diversification matters in all market environments, particularly in times when investors become overly confident.
Portfolio diversification is crucially important for several reasons:
Expecting the Unexpected
Historical market data illustrates that market corrections are inevitable and unpredictable. By focusing only on the near-term trends, investors could be leaving themselves vulnerable to larger losses, not just potentially enjoying larger gains. Help keep your clients in check by borrowing examples from history to show them that a downturn could have a more devastating impact if they’re not expecting it (and if they’re not properly diversified).
Training for the Marathon, not the Sprint
When it comes to building and managing an investor’s portfolio, long-term goals are ultimately the benchmark. Advisors are tasked with helping their clients achieve their individual, overarching goals, which takes time and patience. Over many years, the market will have ebbs and flows, but a diversified portfolio can help investors weather these storms. It’s not about making fast cash now; it’s about being prepared for both the ups and downs over time and hopefully achieving the intended objective in the end.
Balancing the Bad with the Good
While it is easy to feel invincible when the going is good, having a diversified portfolio can also help investors feel protected when the going gets rough. With diversification, when one asset lags, another asset can pick up the slack, helping investors mitigate the pain of a downturn. Advisors should explain this give-and-take to investors so that they understand that diversifying their assets can help them participate in the ups while also hedging devastation in the downs.
For these reasons and more, diversification remains an important component of building a sound portfolio. While enjoying the benefits of a bull market, advisors should be careful not to get complacent, and not to let their overly confident clients get too audacious. Continue to preach diversification even during a bull market, so that clients don’t get stuck by their proverbial horns in the end.
All investments are subject to risk, including the loss of principal. Diversification does not ensure a profit or protect against a loss in declining market.