Index To Portfolio Construction Content

An “irrational quest for safety drove all kinds of nutty economic and investment behavior in 2011.” So said the Chairman and Chief Investment Officer of the brokerage firm, T. Rowe Price, a couple of weeks ago at a media conference in New York, as reported by Advisor One, an on-line investment newsletter for financial professionals.

He went on to say that “irrational thinking explains … why people are terrified of risk and volatility.” I can understand the frustration. When the markets take a downturn, many advisors and their investor clients sell their investments and park their money in cash. In other words, they sell when the market is low, and want to wait until prices rise before they get back in.

Whenever I review a prospective client’s investment portfolio, I rarely see one that is truly globally diversified. The biggest problem I see is that most people are woefully over-weighted in US stocks. To make matters even worse, its usually exposure to just large US company stocks.

Their advisors might have placed them into General Motors, GE, Verizon, Proctor & Gamble, Johnson & Johnson, and similar large stocks.

The problem here is that the investor thinks he or she is properly diversified, but in reality, they have several sectors representing only two asset classes. So when one of the stocks rises, generally they all rise. But when one drops in price, more often then not they all drop. The result: unintentional wild swings in account values.