Veronica Willis, an Investment Strategy Analyst with Wells Fargo Investment Institute, discusses the potential benefits of diversification—which we believe will become increasingly important as the current recovery ages, and volatility picks up.
Transcript: Diversification Can Help Navigate Late-Cycle Volatility
2016 was a volatile year that taught us some valuable lessons about the potential benefits of diversification, and we expect this volatility to increase in 2017.
Many different asset classes contributed to a diversified portfolio's return. Various asset classes, sectors, and styles took turns at leading at different times throughout the year.
As we saw in 2016, when the market fluctuates significantly, investors could potentially benefit from holding a portfolio that includes stocks, bonds, real assets, and if qualified, alternative investments.
This will become increasingly important as the current recovery ages, and volatility picks up.
Now that we are later in the economic cycle, central banks are less likely to take action that provides insulation from volatility.
Diversification may help to protect against market volatility by combining low correlated assets that vary by asset group, asset class, country, and sector.
Additionally, a diversified allocation has the potential to enhance long-term performance and help reduce risk.
Using any single asset class, or even asset group, greatly increases the risk that investors will not reach their longer-term financial goals.
Instead, we believe employing the different characteristics of multiple asset classes through varying market cycles is the key to reaching those goals.
We do not know what market-altering events will take place in the coming year, nor do we know what impact they will have on different asset classes.
We do, however, believe that holding a diversified portfolio can be beneficial in a variety of market conditions. Keep in mind that diversification is an investment method used to help manage risk.
It does not guarantee profit or protect against loss in declining markets.
Title graphic: Investor Implications We think the most important step for investors to take is to define their investment goals and develop a plan to help reach those goals.
Most investors' goals can be grouped broadly into three categories: Income, Growth and Income, and Growth.
Then, asset classes can be matched to your individual goals depending on your specific income and liquidity needs, return expectations, risk tolerance, and time horizon.
Income investors can benefit from a more steady income stream provided by a larger allocation to global bonds and income-producing alternative investments.
Growth and Income investors can benefit from a mix of global bonds, stocks, real estate investment trusts, or REITs, commodities, and alternative investments.
Growth investors may have a greater chance of meeting their goals if they are more heavily exposed to assets such as global equities, REITs, certain types of bonds, and alternative investments.
Unsuspecting investors may be caught off guard by changing market conditions that lead to rapid asset class and sector leadership changes.
While we expect further volatility in the months ahead, diversification can help to be an antidote to large swings in portfolio returns.