Why traditional diversification is dumb, and how to time the market

Yes, I just implied that you can time the market. But what does that have to do with diversification? It has everything to do with diversification and why I think traditional diversification is not useful. There's only one scenario in which I think traditional investment diversification is useful for people. If you're the type of person that doesn't want to take time to review your investments and you just want to "set it and forget it". But if you want to get more for your money you will have to invest more than just dollars, you have to invest your time. Not necessarily a lot of time, but enough to be aware of various market outlooks. A simple search on "Market Sectors" will give you plenty of general information to start with.

First of all I'm only going to be discussing investments of stocks/bonds/index funds/mutual funds/CD's, I am not considering investments in things like real estate or other income generating streams of income.

Traditional advisors and most financial institutions recommend that you should have your money spread out pretty much everywhere, and based on your age and risk profile it will tell you to concentrate more on some areas than others. I think this way of investing is dumb. I'm relatively young (31) and every website I could find online about how I should be diversified said that I should have about 5%-10% of my money in bonds. Over the past year bonds have been getting killed compared to the rest of the market. Why would I put 10% of my money into something where the value is declining and the outlook is that it's not going to get better for a while. That doesn't make any sense to me.

Those same sites tell me that I should have had a certain percentage of my portfolio diversified into international stocks. Right now, that market looks like it's starting to get better and I think it's an alright place to be, but 2 years ago the US market was providing good returns and European markets were struggling to stay afloat. So why should I have my money in Europe when it can't keep up. A lot of traditional investment diversification strategies say that I should also have about 5% of my money in REITs (Real Estate Investment Trusts). I actually had a significant amount of money on REITS for about a year and a half, but once the interest rates started rising the REIT market got destroyed and some REITS have even lost over half of their values. I got out of them once I sensed there was trouble on the rise for them and I'm glad that I currently don't own them.

Think about it, if someone told you cars could run on pineapple juice wouldn't you want to invest in pineapple companies? Or what if you heard that pirates robbed 1 out of 3 ships in the ocean, wouldn't you NOT own any company that runs cruise ships?

Right now I don't own any CD's, that's because their returns are linked to interest rates and they are near historical lows at the moment. There was a time when you could get a 6% or more return on CD's which is guaranteed over a certain amount of time. For a basically no risk investment that's not a bad option, but right now their returns can barely beat inflation. So right now I wouldn't bother putting any money there.

Look at the broader markets and know what to avoid

Are you starting to see what I'm talking about here? I'm not saying buy this stock one day and a week later sell it and you made X multiples of money. I'm saying that you should time markets in general. Why would you invest money in CD's when interest rates are so low and the returns on them are so small? because it's safe? because the end of the world is coming? If you are that kind of person, I bet you thought that Y2K was going to stop all of the financial markets but it didn't. If you're worried about a market crash, then you probably shouldn't be investing in stocks anyways. You can't predict a major crash, I once heard someone say, "a boxer is rarely felled by the hit he see's coming" when referring to quantitative easing. Everyone knows it will happen and the markets will see it coming and react before it comes. It may pull back but it won't destroy everything. But a major market crash comes from left field and it's hard to prepare for, that kind of preparation is a different topic all together.

Anyways, back to diversification. One of the reasons people say you should put money into all areas and to rebalance your portfolio is because it forces you to buy low and sell high. I see that being useful if you are the average investor that wants to just sign up for their companies 401k and "let it ride" until you retire 40 years later. But I assume that if you are reading this you want to take more financial responsibility over your money.

I'm not financial guru, but here are some outlooks I currently have:
  • Technology is on the move again, I'm not sure how long it may last but you shouldn't ignore it.
  • Healthcare/Biotech has been great this year because of the healthcare changes, I see this continuing for now
  • Consumer Cyclical is going well because the economy is starting to recover more
  • CD's aren't worth the time at the current rates
  • Bonds are also not worth it at the current rates
  • European markets are recovering, might not be a bad time to jump in
  • REITs and mREITs, with interest rates rising STAY AWAY
  • Utilities have been a poor performer. I wouldn't bother with these right now
Some of my views may not be spot on but I'm paying attention. I think it's good to know what areas are not doing well and stay away from them and what areas are doing well and make sure you don't ignore them.

I like to view all my investments from all angles, so here's why you shouldn't listen to what you've just read. First, investments can go down quicker than they go up, and with all of the increases this year many of these "hot sectors" could be due for a correction.

I know that you can't always pick the winners but I think that one of the better strategies you can use is to avoid the sinking ships. And learn to bail out when the future looks grim.


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