Managing investment risk and diversification

Would you like a response to a financial question? Send your question to Doug Horn, 115 W. Broadway, Maryville, TN 37801. Be sure to mark your envelope Money Matters. Doug Horn, CFP, is an area financial planner with more than 24 years financial experience and founder of Quality Financial Concepts, located in downtown Maryville on Broadway.

If your investment portfolios are feeling the pain of getting out too soon and back in the markets too late, then a lesson on managing risk may be beneficial. Warren Buffet said it earlier this year as well, if you wait to see the robins, you have already missed spring.

Investment assets for the individual are always personal. They can represent the safety of your financial future and sometimes your persona. When something is this personal, trading or managing it can be very difficult. This is often proven true when individual traders fail to sell a holding that has fallen. However, as soon as it nears it original purchase price the position is often dumped and the proceeds are invested elsewhere. There are instances when the time between the purchase and sell date is months, but it can also be years for some investors. When an investment has gone bad, many investors wait for the position to get back as close to the purchase price as possible and then sell it. This waiting can result in a missed opportunity if it takes too long for the position to recover.

Investing will always result in gains as well as losses. The obvious trick is to have the total of the gains out distance the total of the losses. If you are afraid of taking a loss, then managing investments is something you should not do. During 2008, one in four stocks lost more than 75 percent per Don Philips with Fox Business News. However, only one is fifteen thousand mutual funds lost that amount of value.

Mutual funds are still a great way to manage investments and risk. Own one fund and you have instant diversification. While the diversification is one of the best tools to avoid significant losses, it can also slow the recovery of a portfolio if the diversification is too great.

Mutual funds must follow strict rules and strategies when managing money. It is this discipline that creates records and often consistency. However, during periods following severe market corrections, the use of only mutual funds may slow the recovery of your portfolio. Funds have limits on investing in each holding within the fund. Due to the size of many funds, the managers are often forced to start investing in their second and third tiers rather than staying in their top group. The impact of adding investments from the second and third tier is obvious, it slows the growth; but in today’s low interest rate environment, the returns may be better than that of cash.

But, as mentioned earlier if one in four stocks lost more than 75 percent of its value then clearly, there are many quality companies whose value may recover far faster than a diversified mutual fund. If you are not sure of this, just review the returns of many of the individual stocks within the S&P 500. I am not saying diversification should be thrown out the window. But creating a personal mutual fund may result in very satisfactory results.

Mr. Buffett stated he would rather be out of the market when everyone is greedy, and be a buyer of the market when everyone is running away. During the last year, the opportunity for Mr. Buffett to follow his own advice has been clear.

The markets remain significantly below their peak values from 2007. Thus, I expect better than average returns for the next year or so. This will not be without the occasional pullback, but as the American consumer gradually reenters the market, many quality stocks will continue their rise.

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