Diversification in Investments Can Limit Risk

Be Honest with Yourself About Your Risk Tolerance Level - Make Good Choices

March 4, 2007
By: Jerry Cole - Retirement, Investment

When I discussed risk tolerance in last week's column, I had no idea that the market plunge on Tuesday, February 27, 2007 would give us such a harsh example with which to test ourselves.

The selling pressure was quite extensive. The Dow Jones Industrials finished the day down 415 points, or 3.3%. The NASDAQ Composite Index was down more than 96 points, or 3.9% and the Standard & Poor's 500 Index was down about 50 points, or 3.44%.

The loss was the largest for the Dow since right after the terrorist attacks in September of 2001. It was accompanied by the largest volume ever on the Dow; 2.3 billion shares. There are many possible causes for the downturn. A huge pullback in China on the Shanghai market, a suicide bombing attack in Afghanistan at the main U.S. military base where Vice President Cheney was visiting, a 7.8% fall in durable goods orders etc. Take your pick. The fact is this WILL happen from time to time.

The question is how do you react? Was it a one day event? Was it the beginning of a market correction which could, over some period of time, bring the market down over 20%?

Some investors pressured by the fear of falling stock prices will seek the safety of Treasury bonds. This will drive up Treasury prices and result in lower yields. However, if interest rates should subsequently rise, those investors will see an erosion of their bond prices.


One thing that you can do is to be suitably diversified in your investments to begin with. The degree of diversification depends on your risk tolerance and your time horizon (the length of time before you may need funds from your investments).

Diversification means more than just buying a particular mutual fund or a family of funds. And you are not necessarily diversified by owning funds invested in other countries. The best diversification comes from investing in disparate asset classes I.e. stocks, bonds, exchange traded funds, mutual funds and short term fixed income assets.

Again I remind you to be as honest with yourself about your risk tolerance as you can be. It will help you to absorb the perturbations of the market and make the right investment decisions for you.

I invite your questions. E-Mail Jerry Cole

The opinions expressed are solely those of the author and not Genworth Financial Securities Corporation.