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Why Diversification Is Still King

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Why Diversification Is Still King

Written by: Kyle Thompson

If you have watched the news or read the headlines over the past week you would think the markets were decimated yesterday with multiple reports indicating that the Dow experienced its worst day in history. This type of fear mongering is aimed to act on your emotions and I think it’s important to separate fact from fiction.  The Dow did close 1,175 points down on February 5th, which is the single highest point drop in a day, but the percentage decline of 4.6% was not even close to the worst day in history.  Furthermore, it can be expected that the higher index values will lead to larger price declines – this is a basic mathematical equation.  The percentage change is always a better measure when looking at market performance. 

We have seen a percentage decline of 8.3% from the Dow’s record high close on January 26 through the end of the day yesterday.
 

This is still below the correction territory of 10%. In March, this current bull market will turn nine years old, which is the second longest bull market in history.  During this time period, the market has seen four official corrections (moves of 10% or greater) and 60-some “panic attacks”. Do you remember the market reactions to the 2010 Flash CrashBP oil spill in 2010US debt downgrade in 2011Eurozone double-dip recession in 2012Taper Tantrum in 2013Ebola scare in 20142015-16 Chinese stock market turbulence, etc.?  If you heeded the warnings of the media at any point over the last nine years your overall investment returns would have been negatively impacted and you would have missed 96 new record highs in the Dow since the 2016 presidential election.  

What has caused the recent market volatility and when did good news become bad news? 
 

The market has clamored for rising wages for years and the irony is that last week’s labor report, which showed wages increasing by 2.9%, is likely the main culprit of the current volatility. The markets are concerned that wage and price inflation will accelerate faster than expected and the Federal Reserve is going to be forced to raise rates at a quicker pace than anticipated.  As rates rise, investors become concerned that it could choke the economy and lead to a rotation out of stocks in favor of the stability of bonds.

Related: Why Estate Planning Is Easier and More Important Than You Think

So, what should you do with all this noise? Our advice will sound familiar: tune out the market commentary and focus on your long-term financial goals.  Your long-term financial plan with Market Street already has market volatility built into your results.  These short-term gyrations should have little to no impact on your long-term goals, and therefore the best thing to do is to stay the course.

Seeing the markets reset is both healthy and expected and is needed to keep moving forward. We are often asked during raging bull markets why we hold certain asset classes, including cash.  Yesterday was a perfect example of why diversification is still king and why cash has its place in your portfolio.  While others fret over the market’s next move, we will sit back and continue to take advantage of the irrational behavior by managing your portfolio back to your target allocation via dynamic rebalancing (sell high / buy low).  

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