INVESTING: Diversifying in right way not as easy as it sounds

When you talk to your financial adviser and he tells you to diversify your investments, you are supposed to find ideas that do not move in direct sympathy with the stock market. In other words, put your money in non-correlated asset classes.

The concept here is that, when one area of your portfolio is not doing well, another part is more than making up the slack. This whole program is wrapped up neatly in a cool term called modern portfolio theory, and it looks great on a pie chart. The problem is that, during a bear market, the pie begins to look rather messy, and it can be a little daunting to keep eating the pie the messier it gets.

There is an old joke on Wall Street that the only thing that goes up in a bear market is correlation. Of course, that depends on how diversified your portfolio is. Even during the Great Depression, there probably was something that worked. In 1930, if you bought a factory that made government cheese, you made money. Someone was making all those bell-bottom jeans in the ’70s. And today, the repo guy is busier than a onearmed paper hanger. But ask yourself this: How much stock do you own in a repossession company?

The entire decade of the ’70s is a perfect example of how wrong modern portfolio theory can go. Equities and real estate represent the largest percentages of invested assets, and stocks spent most of the decade getting killed. The Dow Jones industrial average crossed 1,000 for the first time in 1966, and didn’t cross it again for good until 1982. Real estate did a little better, but not much. Certainly not enough to offset the huge losses in stocks.

Interest rates were on a tear the entire decade, virtually destroying any bondrelated investments in their path. Commodities did well, with gold moving from $35 an ounce to $850 by 1980. Oil showed consistently higher prices for most of the decade as well. But retail and professional investors owned little, if any, of the stuff that was working.

Even today, with the commodity run now into its eighth year, pension funds don’t have more than 10 percent of their portfolios in commodities. Institutions are losing money because they are too heavy in stocks and corporate bonds. And, once again, they don’t own enough of the stuff that is going up.

The real answer to all of this is to take your pie charts and put them under the bird cage. Everything has a season. After gold’s monster run in the ’70s, a lot of experts persuaded people to keep at least some of their money in gold. Those investors suffered for 20 years before gold finally hit a bottom! The annualized rate of return from 1980 to the current price of $920 an ounce is far less than 1 percent a year. But what about buying gold at $275 an ounce in 1999? Now that was a move!

Unless you are retired with limited funds, you want to keep an open mind to moving your money around at least once every few years. The Japanese market hit almost 40,000 in 1990. It is trading below 14,000 today.

Everyone seems convinced right now that the euro is going to move up against our dollar forever. I think the euro will see higher levels, but at some point in the next 10 years it will fall below the dollar. It might even end up worthless as countries discard it. You will hear from Italy in the next few months on this matter.

The point is that nothing lasts forever. There are times you want in on certain investments and times you want nothing to do with those same investments. To simply say “stay diversified and focused on the long term” is the lazy man’s approach.