DIWORSIFICATION: THE PROBLEM WITH SPREADING YOUR PORTFOLIO TOO THIN – March 03, 2023
The concept of diversification has long been hailed as the holy grail of investing. The idea is that spreading investments across different asset classes may reduce risk and create a more stable portfolio. However, there is a growing concern that diversification can lead to over-diversification and a poorly performing portfolio. This is known as diworsification.
Diworsification is a result of adding assets to a portfolio simply for the sake of diversification without considering whether those assets will actually benefit the overall investment strategy.
What most investors don’t realize is how strong the correlation is between most stocks, sectors, and indexes. It does not matter which group or type of stock an investor holds in their portfolio. The bottom line is that when the stock market falls, almost all stocks fall. The main difference is that some fall more than others, and there are two silent account killers that destroy retirement dreams. Meaning that investors who spread their money out over several sectors thinking they are diversified and more protected, could not be further from the truth.
In fact, owning specific sectors can increase one’s risk because sectors, in general, are a smaller segment of the whole market and thus can rise and fall faster than the broad index.
This can lead to lower returns, higher costs, and increase risk substantially. Diversification is a byproduct of the buy-and-hold method, which puts investors over the age of 50 at serious risk because of what is called the Sequence of Returns Risk.
Investors can avoid diworsification by exploring alternative investment strategies that can help them achieve their financial goals more efficiently. In fact, there is a growing trend where investors are challenging the old status-quo buy-and-hold strategy.
Tactical ETF Investing:
A Different Approach to Building Wealth
One alternative investment strategy gaining popularity is tactical investing. Tactical investing allows investors to grow their capital without diversification. Instead of spreading investments across assets, tactical investing allows investors to focus on the assets that are performing well while avoiding those that are not.
Tactical investing works by selling assets as they start to top out and reinvests the money into other assets that are rising in value. This strategy is the polar opposite of the old buy-and-hold method used by firms like Fidelity, Schwab, and financial advisors in general. Tactical investing allows investors to avoid holding falling positions and instead focus on assets that have the potential for growth.
What makes tactical investing different from traditional diversification is that it does not rely on spreading investments across asset classes at the same time. Instead, it relies on an asset hierarchy and rotates capital into assets that have the most potential for growth. A strategy that uses an asset hierarchy is CGS.
The benefits of tactical investing are clear
Tactical investing allows investors to focus only on the assets that are rising while avoiding those that aren’t. This strategy can lead to higher returns and lower costs, as investors are not paying fees and expenses for assets that are not contributing to their overall investment strategy.
Additionally, tactical investing allows investors to take advantage of market volatility. Instead of riding out market fluctuations, investors can avoid falling prices altogether and limit their downside risk. Some tactical investing newsletters have strategies that can generate additional gains during market corrections using inverse ETFs.
Top ETF Brands for Tactical Investing
When it comes to tactical investing, investors have many options to choose from when selecting an ETF. Some of the top brands that work well for tactical investing that I use are:
- Invesco ETFs like QQQ, UUP, and UDN
- State Street ETF SPY
- iShares ETF TLT
- Proshares PSQ and SH
Overall, these top ETF brands offer a wide range of choices to meet the specific needs of investors looking to achieve financial efficiency through tactical investing.
Concluding Thoughts
While diversification has long been considered a key strategy for building a successful investment portfolio, the concept of diworsification highlights the potential downside of diversifying your portfolio.
Instead, investors can consider using tactical investing to grow their capital without diversification by reinvesting their money into different assets rising in value and avoiding holding positions that are falling. By carefully selecting the right ETF for various assets, investors can fast-track their portfolios to reach retirement sooner and for retirees to live a richer lifestyle.
Author: Chris Vermeulen