Make Sure You're Really Diversified

by Alan Lavine and Gail Liberman

When you invest, diversification--or mixing up your investments—has been key to getting attractive performance without losing your shirt.

The problem: It’s harder these days to diversify.

It used to be that if you owned an equal amount of stocks and bonds, you were diversified. Owning both foreign and U.S. stocks also helped you diversify.

But many tried-and-true strategies no longer diversify your investments as much as you might like. Plus the nature of the investments that keep you diversified may change over time.

Overseas stocks, as well as small company, medium company and large company stocks, are moving along with the overall stock market, notes Milton Ezrati, economist for Lord Abbett & Co., Jersey City, N.J. Everything seems to be up and down at the same time.

Hedge funds and commodities may move in the same direction as stocks.

“Even many managed bond funds exhibit higher correlations with U.S. (stocks) than they once did,” he says.

When you want to diversify, all this is bad news.

So what can you do to play it safe?

Ezrati says the trick may lie in picking the right types of bonds.

High-grade bonds, like U.S. Treasury bonds, government agency bonds and corporate bonds rated A to AAA by Standard & Poor’s, continue to have a negative relationship to U.S. stocks, Ezrati says. That’s what you want.

But some bond funds may be investing in riskier bonds that move in line with the performance of U.S. stocks.

To keep returns attractive in the face of low current yields on Treasuries, agency bonds and high-grade corporate bonds, some managers have bought riskier bonds.

They’ve turned to junk bonds, convertible bonds and asset-backed bonds.

“Such bonds have valuable uses,” he says, “but diversifying (stocks) is not one of them.”

Alan Lavine and Gail Liberman are husband-wife personal finance columnists, journalists and authors. They are the authors of "Rags To Retirement," published by Alpha Books. Their columns appear in newspapers throughout New England and the Southeast, as well as online. Their commentary on mutual funds and personal finance is carried by 200 radio stations nationwide every Sunday over Business News Network's Charles DeRose Financial Advisor Show. Al and Gail’s new book is "Rags To Retirement:  Stories from people who retired well on much less than you think," published by Alpha Books.

More articles by Al and Gail can be found here.