As The Market Swoons, Don’t Forget to Diversify
The markets had a large sell-off to close the month of April. It pushed the return of the S&P 500 Index down 14% year-to-date.
The tech-heavy NASDAQ Composite Index is now down 22% year to date. The NASDAQ is firmly in bear territory, and the S&P 500 is approaching that threshold.
The current sell-off is in fact worse than most of us have seen to start a year. From a historical perspective, the S&P 500 is off to its worst start of the year since 1939, and the NASDAQ is off to its worst start ever.
Regardless, the key to successful investing over the long term is to invest consistently across bull and bear markets alike. Don’t let the current sell-off scare you away.
Diversification is critical. Those who are overly concentrated in technology stocks have seen great gains in recent years, but they’re also bearing the brunt of the current slump.
There’s a well-known story about a secretary at Enron who became a multimillionaire on paper as Enron’s stock soared. But she kept it all in Enron stock. That was great when the share price was soaring, but when the company collapsed, she lost everything. She had all of her eggs in one basket, one of the most basic investing mistakes.
I have had friends in similar situations. They got stock options in a startup, and the value of their options soared. I always given them the same advice. Take some of that money and diversify it into other sectors.
So the first lesson here is “Diversify.” What is the best way to achieve this?
There are mutual funds and exchange traded funds (ETFs) that invest in basically the entire stock market. Funds like the Vanguard Total Stock Market Index Fund (VTSMX) are popular with many investors because they provide maximum diversification. You can invest in similar funds that invest strictly in companies in the S&P 500, or in the NASDAQ Composite Index. But beware the latter, because you’re losing out on some diversification. The NASDAQ is heavy in technology stocks, and those are presently in a bear market.
My preference is to spread my investments across the 11 major sectors that make up the S&P 500. These sectors are Communication Services, Consumer Discretionary, Consumer Staples, Energy, Financials, Health Care, Industrials, Materials, Real Estate, Technology, and Utilities.
Again, there are ETFs devoted to each of these sectors. Select Sector SPDRs are targeted ETFs that comprise 11 sector index funds. But the 11 Select Sector SPDRs represent the S&P 500 as a whole. Therefore, if you take that approach, you may as well just invest into an S&P 500 ETF.
My preference is to select a handful of promising stocks from each sector that meet my personal needs. I seek out stocks that pay dividends and have low volatility, among other factors. That gives me diversification, but it also more control about the types of stocks in my portfolio. In this way, I am giving up maximum diversification for more control. But I maintain significant diversification.
You must take the approach that’s right for you. But one way or another, you need to get your portfolio diversified. Too many fortunes have been lost because investors who made quick gains didn’t properly spread the risk.
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