The Death of Diversification, What You Don’t Know Will Hurt You

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The Death of Diversification: What You Don’t Know Will Hurt You

Raise your hand if your retirement portfolio lost 30-60% during 2008 and 2009 or lost 30-60% during 2001 and 2002, or both!

When it comes to protecting our retirement investments from major losses, what we’ve been taught just doesn’t seem to work anymore. We’ve been told that if we just own enough different stuff (large-company growth funds, small-company value stocks, mid-sized blended, large company international funds, emerging market funds, etc.), when one investment goes down the others will go up and our retirement monies will grow in a dependable, low-risk way.

If this was ever true, it hasn’t worked that way for the last 15 years. In 2001 and 2002, every major stock asset class went down 30 to 60%, even more, if you owned a lot of tech stocks (and just about everybody did whether they knew what was in their funds or not). In 2008 and the beginning of 2009, every major stock asset class went down 30 to 60% again!

diversification computer

This has had a devastating effect on long-term growth rates. For example, since January of 2000 as of today the S&P 500 has only averaged a 2.4% annualized return, the NASDAQ only 1.4% (your 401-k grew by more but that’s because you were adding money over the years). You could have done better with CDs!

So, if the basic truth of portfolio management doesn’t work anymore, how can you protect your retirement from a devastating loss? If you’re in your late 50s or early 60s this is a very serious question. Another 2008 type market drop WILL affect how much longer you need to work or whether you need to count pennies for the rest of your life. Maybe that sounds harsh but if you lost 30 60% of your portfolio again right now could you retire when you would like and lead a comfortable lifestyle for the next 20 to 30 years without running out of money?

Poll: 72% Fear Economic Crash, Concern Highest Ever

That’s what a recent headline in the Washington Examiner reported as the results of a nationwide poll.

Whether a major downturn is imminent or happens somewhere down the road, let’s talk about what you can do now to protect your retirement portfolio and your quality of life in retirement.

Three Steps You Can Take Now to Protect Your Retirement Lifestyle

Diversification is dead, at least the way it’s been practiced for about the last 20 years. We’ve basically been asking stocks and mutual funds full of stocks to behave well, and they haven’t. Even bonds, one of the few asset classes that held their own during the last downturn probably won’t be doing so in the next one.

While the markets are still up, we need to go back to the basics when it comes to managing our retirement money.

1) Re-Allocate a Portion of Your Portfolio to Create Income

If you are in your late 50s to early 60s you need to plan for how to have the income you’ll need in retirement. Social Security is not going to cut it and unless you’re fortunate enough to have a large (dependable) pension, you’re going to need to generate safe, dependable income to live on when your paychecks stop.

We used to use bonds for this purpose. The closer we got to retirement the more we moved from stocks into bonds. This did two things: it lowered the risk of our overall portfolio and created a safe dependable income to live on. With bond interest rates at historic lows, they are not going to be able to either lower our risk or provide a reasonable amount of income for the foreseeable future. So what can we use to replace bonds as a retirement tool?

There’s a relatively new class of annuities (no they’re not your grandmother’s annuity, they don’t have high fees and they stay in your family after you’re gone) designed to grow with the market on the upside, to protect your retirement money when the market goes down and most importantly to provide a high level of safe, dependable income throughout your retirement.

You can re-allocate just enough to this portion of your portfolio to supplement your Social Security so that you have the necessary income to support your retirement lifestyle. Or, you can allocate more as you look to create less overall risk and more income.

2) De-Stress Your Growth Portfolio

Why do people run out of money in retirement? It’s because they’re drawing out more money to live on than their portfolio can tolerate. They’re stressing their portfolio. This might work when the markets are going up but during a market correction they eat away at their principal leaving less to recover. Eventually, they can run out.

When you create income on a dependable basis as in #1 above, you lower the stress on the growth portion of your portfolio. Your growth portfolio is no longer responsible for month-to-month living expenses but takes on the much easier task of staying up with inflation over time. If you’ve lowered the withdrawals from your growth portfolio from the 4-6% range to only 1 to 1.5%, this part of your portfolio is free to grow over time to provide security during your retirement and a legacy when you’re gone.

3) Manage Your Growth Portfolio First For Risk

Finally, you need to manage your growth portfolio first for risk and THEN for return. In our 20s, 30s, and 40s we build our portfolios around growth. For example, we choose our 401-k investments based upon our selection of the best-performing funds. If we have a large loss we have 20 years to make it up again.

When we’re in our 50s and 60s we don’t have that luxury. Any large losses WILL affect our retirement, sometimes dramatically. During this stage of our lives, we need to re-focus the way we approach investing for growth. We need to first manage our portfolio to control risk and then manage for growth. That doesn’t mean we can’t achieve really solid growth. Ironically, by simply not losing a lot over the last two market corrections your overall return could have been exceptional, with the added benefit of sleeping well.

Our preferred method for accomplishing the above is by using third-party independent money managers, screened for their ability to control risk, to actively manage portfolios of low-cost index funds.


Since diversification, as it’s been practiced, hasn’t been working for the last 15 years, we need to take a more proactive approach towards reducing risk and preparing for a safe and comfortable retirement. Re-allocating a portion of our portfolios to safe dependable sources of income, de-stressing our growth portfolios, and managing those portfolios for risk reduction first and then return will go a long way towards a successful retirement.

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