Diversification is often thought of, in terms of asset classes and age groups. You will normally hear that the weight of equities in your portfolios should decline, as your age increases.
So while it is fine for a thirty year old to have 70% equities, a 50 year old is much better off with only 30% equities.
So if you are thirty years old, should 70% of your portfolio be invested in stocks, regardless of stocks being at all time highs or lows?
Asset Prices and Diversification
I have never heard of diversification with respect to asset prices. The point is that asset prices move in cycles and you should diversify keeping the current cycle in mind.
About a few months back, stocks were trading at all time highs, and a lot of people made a lot of money. At that time it would have been prudent to reduce exposure to equities and move into safer instruments like money market funds. That would have been true, regardless of age or the other asset classes in your portfolio.
The fact that you are just 25 years old doesn’t protect you from sliding stock prices. It helps you because you can wait a longer period for stock prices to recover. But it doesn’t protect you from the slide that happens at that point in time.
The fact that stocks are at 11 year lows today; make them cheaper than other assets. This should be the time to increase your exposure to stocks because stock prices are lower and the value of “money” is higher.
IfÂ you view money as an asset class (which most people don’t) you’d realize that today you can buy more stock per dollar than any other time in the last 11 years. That makes money expensive and stocks cheap.
Which indicates that you should move out of money and move into stocks.
I know that the key assumption that I make here is with respect to stock earnings. The assumption is that in the long run; the earnings will continue to rise. In the next few quarters the earnings may go down, but in the next 11 years they will rise steadily.
If you disagree with this assumption and see a deep recession or depression coming, then you are better off without stocks. The other reason to stay away from stocks would be, if you thought something else could make you more money; like gold. Else, investing in stocks at this time may not be a bad idea at all.
How do you think about diversification? Do you think in terms of asset prices or in terms of asset classes and age groups?