Matthew Tuttle, President
Tuttle Wealth Management
May 2009
We often hear that investors need to have diversified portfolios to protect against market volatility. However, as many investors found out during the bear markets of 2000-2002 and 2007-2008, a traditionally-diversified portfolio does not provide much downside protection when the market crashes and takes everything down with it.
The traditional theory of diversification comes from modern portfolio theory. The idea is that if investors add non-correlated assets to their portfolio, they can increase returns and lower risk. While this is true in theory, in practice it is very hard to achieve. When most investors think about a diversified portfolio they think about large stocks, medium-sized stocks, small stocks, international stocks and bonds. A more advanced investor might also have allocations to hedge funds and private equity.
The problem with this approach is that during a market crisis most of these types of assets tend to fall at the same time. Diversification will give you some protection, as assets like bonds will probably not decline to the same extent as stocks; but how much comfort is it when the market is down 40% and your portfolio is only down 30%?
