As a conservative person planning for retirement, here is a lesson you would do well to learn. A lesson from the severe market losses in a year like 2008? First ask yourself, “Will we see another drop like 2008?” Jack Bogle, Founder of Vanguard Funds, the largest index fund company in the world said several years ago, “We are likely to see two drops of as much as 50% in the next ten years”. YIKES! Just one drop anywhere near 50% would devastate most baby boomer’s retirement plan. You may not know it, but all your eggs are in the same basket. The Wall Street basket and all your money is at risk. I call this ‘pixie dust’ diversification’.
I have four brothers. When we were young my Mom would let us each color one dozen Easter eggs for Easter. There were never, ever two eggs alike. They were all diversified. I remember one Easter we put all of our eggs in a basket with some pretend green grass. You know the kind I am talking about. Before we went to church, we put the basket up on the dining table. While we were gone, our dog got up on the table and knocked the basket off and then played with the eggs. He ate some too. Few eggs were salvageable. But wait! All the eggs were diversified. What went wrong? Minor detail, we had a bunch of different eggs all in the same basket. Just like investors in 2008!
If a theory fails its biggest test ever, do you want to use that as your retirement plan? In July of 2009 the editor for Investment Advisor Magazine said, “The wealth management practices of Wall Street firms and big banks are broken. Again.
To understand this point, it’s important to step back and remember that regardless of which particular investment was the flavor of the month, the common theme heard over and over again in the big investment houses over the past 30 years was that by dividing your assets among many different categories that won’t move in the same direction at the same time, you were going to reduce the overall risk.
This premise seemed to have some validity and was appealing to the average investor – until October 2008, when virtually every category except high quality short and intermediate fixed income investments got caught in the same downward draft. Put another way, the Wall Street wealth management model failed its biggest test. Investors who were told that they were diversified suffered losses of double or triple the magnitude of what they were told to expect during a tough year.
What went wrong? The fixed income substitutes pushed by the major investment houses – “low volatility” hedge funds, preferred stocks, asset backed securities or other structured products, closed-end bond funds, income/mortgage REITs, and master limited partnerships – weren’t fixed income substitutes at all. None of them is a substitute for the most important characteristic that investors should be looking for from the fixed income portion of their portfolios: safety of principal. Safety of Principal can only be had from putting some of your precious eggs in a different basket. A basket where you can make money when the market goes up, and NEVER LOSE when the market goes down. You must Risk Less to Spend More.
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