Rule #1

One major tenet of investment is “don’t put all of your eggs in one basket.” Yet investors often fail to follow this simple rule. It is understandable for a novice, but what about those supposedly sophisticated investors who lost millions in Bernie Madoff’s Ponzi scam?

Many victims of this gigantic fraud were banks, investment firms and wealthy individuals. Why did these investors not follow the rule? It seems highly likely that “greed” and/or “mistrust of a master con-man” rank high among potential answers.

So why diversify? The simple answer is to protect against the loss of capital. Any time one invests in a capital market that consists of stocks, bonds and other similar products, there will be some volatility. In other words, all investments other than guaranteed investments carry an inherent market risk, or volatility.

An important objective for most investors is to protect their capital while maintaining a reasonable rate of return.
This requires a well-planned investment strategy. Last year, we saw the steepest market correction since the Great Depression. Many investment professionals now suggest that the worst is behind us and the market could bounce back in the near future. So, how should one prepare to take advantage of a market recovery?

There are three principal ways you can diversify your investment portfolio:

• Diversify by style: Choose several investment managers with differing styles. Markets behave differently during the stages of a market cycle and market leadership rotates between sectors of the economy.

• Diversify by region: Allocate your investments to different regions, which lead at different times. For instance, the developed economies of North America and Europe are currently in a recession, while the emerging economies of China and India continue to grow.

• Diversify by asset class: Invest in a variety of bonds, equities and money-market securities, which behave differently. For instance, bonds can protect the portfolio in equity down-markets. A well-balanced portfolio provides a cushion to market volatility and helps smooth returns over time.

Potential Investors often ask, “When is the right time to invest?” The response of legendary investor Sir John Templeton was “Whenever you have the money.” No one can reliably predict when the market will move up. In the market, time is the secret to success.

While diversification is an important strategy, it’s effective only if investors stay on course through all market conditions. In fact, a strong case can be made for regular monthly investments.

It is important to maintain a strict discipline. Investors are often attracted to a hot sector or asset class at their high points and exit at market lows. This results

in considerable damage to portfolios. Chasing yesterday’s winner is definitely the wrong strategy and doomed to fail. •

Jan Shah is a certified financial planner with Assante Financial Management in Toronto. For personal consultation, he can be reached at 416-221-8566 or jshah@assante.com.