Editor’s note: A couple of weeks ago, we brought to you a simple three-step method for ensuring your investments aren’t over- or under-exposed in any single sector…
It’s a sort of “diversification check” called the “10×10 Approach”… And it’s a great way to make sure your portfolio is balanced enough that no single sector’s failure will wreck your finances… while still allowing you to reap the benefits from other sectors’ successes.
See, the key to protecting and growing your wealth – no matter how good or bad things are in the economy, in the markets, in the world – is diversification across asset classes.
It’s the message in today’s essay from the Daily Cut archive as well. We get into the details of why diversification is so critical. But first, let’s check out today’s market action…
Market Data
The S&P 500 closed down 0.7% to end the day at 5,123.69… the NASDAQ fell 1.2% to close at 16,085.11.
In commodities, West Texas Intermediate crude oil trades at $77.89, down $1.03…
Gold is $2,184 per troy ounce, up $19 from yesterday…
And bitcoin is $69,280, up $1,684 since yesterday.
Now, back to our story…
Is this a “good” or “bad” economy?
It’s like one of those inkblot tests psychologists give patients to learn about their state of mind.
When folks in the “bad” camp look at the economy, they see high inflation… high interest rates… and collapsing banks.
Folks in the “good” camp see record-low unemployment.
And they’re both right to a degree…
To say the economy is good and bad at the same time isn’t a neat answer. But it’s the reality of the situation.
That means it’s more important now than ever that you play offense and defense in your portfolio.
So, today, we’ll look at why this is so critical. Then I’ll go over the necessary steps for you to apply this to your own wealth-building plan.
When you’re diversified, you have eggs in different baskets…
You don’t have all your money in only stocks… cash… bonds… real estate… gold… or crypto.
Instead, you make sure you own a mix of these different asset classes. (That’s Wall Street speak for a group of investments with similar characteristics.)
Studies show that asset allocation – not stock picking – accounts for more than 90% of the variation in performance between different portfolios.
But a lot of financial publishers avoid discussing this with their readers. It’s easier to keep you diverted with the next exciting news story than the “boring” stuff that actually helps you build and hold on to wealth.
We’re no strangers to big ideas about how you can make outsized returns in the markets.
That’s why I spend so much time talking about crypto, pre-IPO opportunities, and under-the-radar speculations such as stock warrants.
But it’s also important to master the basics of investing before you put your hard-earned cash to work. Otherwise, you risk making yourself poorer, not richer, as an investor.
How does diversification help you grow and protect your wealth?
To answer this question, let’s compare two portfolios. Both are made up of cash, gold, and stocks… but are split different ways.
Portfolio No. 1 has 5% in cash, 5% in gold, and 90% in stocks.
Let’s assume for now that nothing happens to cash and gold, but stocks crash.
A 50% drop in stocks would mean a 45% loss in your portfolio. (90% / 2 = 45%).
Now, let’s say you’re a more cautious investor. Maybe you’re about to retire. You can’t stomach a 45% loss. So, you go for the more defensive mix of Portfolio No. 2.
It’s split evenly among stocks, cash, and gold. Now, that same 50% plunge in stocks leaves you with only a 16.5% drawdown in your portfolio. (33% / 2 = 16.5.)
That’s not great. But it’s survivable in a way that a 45% loss is not.
That’s not the only benefit of this strategy…
If you have a chunk of your portfolio in cash, you can go shopping for bargains in a bear market.
And gold tends to zig when stocks zag. So, a rising gold price will offset losses to your stocks.
Think back to September 15, 2008. It’s the day Lehman Brothers declared bankruptcy.
Back then, gold traded for $787 an ounce. Three years later, it peaked at $1,900 an ounce. That’s a 141% jump during one of the worst times for stocks.
If gold soared as much in the next crash, what would it mean for Portfolio No. 2?
Instead of losing 16.5%, you’d make 21%. Because your gains in gold would more than offset your losses in stocks.
You always want to play offense and defense like this…
As I mentioned it’s hard to tell whether the economy is doing well… or terrible.
If you get a bunch of economists in a room, they’ll disagree. Same goes for a bunch of media pundits. There’s even disagreement among the analysts here at Legacy Research.
That’s why it’s best to own investments that do well in good times as well as investments that do well in bad times. You’re prepared for either outcome.
Stocks, for instance, allow you to play offense. The stock market tends to do well when the economy is growing… jobs are abundant… and investors are upbeat about the future.
Bonds are the classic defensive asset. They tend to go up in price when investors see trouble on the horizon and are scrambling for safety.
Here’s a more extensive list…
You want to own a mix of assets from the left along with a mix from the right column.
Exactly how you divvy up your portfolio is up to you…
If you’re more bearish, you’ll want more cash, bonds, gold, and collectibles.
If you’re more bullish, you’ll want more stocks, warrants, pre-IPO (“initial public offering”) stocks, and crypto.
Just resist the temptation to go all out on defense… or all out on offense.
If you’re too defensive, and the bulls turn out to be right, you’ll miss out on gains. If you lean too far into offensive assets, you’ll risk getting wiped out in a crash.
Thankfully, you don’t have to lean too far in either direction. By spreading your wealth across defensive and offensive assets, you’ll do well… no matter who’s right about the economy.
More Markets
Today’s top gaining ETFs…
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Amplify Transformational Data Sharing ETF (BLOK) +2.2%
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KraneShares MSCI China Clean Technology ETF (KGRN) +2%
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Pacer Benchmark Industrial Real Estate SCTR ETF (INDS) +1.9%
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iShares Residential and Multisector Real Estate ETF (REZ) +1.3%
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Nuveen Short-Term REIT ETF (NURE) +1.3%
Today’s biggest losing ETFs…
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iShares Semiconductor ETF (SOXX) -4.1%
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VanEck Semiconductor ETF (SMH) -3.9%
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First Trust Nasdaq Semiconductor ETF (FTXL) -3.9%
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Invesco Semiconductors ETF (PSI) -3.8%
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SPDR S&P Semiconductor ETF (XSD) -3%
Regards,
The Legacy Editorial Team