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23 May

For investors, asset diversification pays off if you do it right

Mark Armbruster

Individual investors make bad decisions. That is the conclusion of a recent study, showing that 401(k) plan investors are increasingly tilting their accounts toward stocks although stock market valuations have risen significantly.

According to the study from Aon Hewitt, stocks now account for 67 percent of employees’ new contributions to their employer-sponsored retirement plans. The study notes that this is the highest level of commitment to the stock market since March 2008, up from a low of 48 percent in February 2009. The market was relatively strong in March 2008 but deep into the throes of a bear market in February 2009. So investors tend to put more money into stocks when the market is high and less when the market is low. That’s not the best recipe for success.

Indeed, a study by finance professors Brad Barber and Terrance Odean found that most individual investors hold underdiversified portfolios and “trade actively, speculatively and to their own detriment.” The study showed that individual investors underperform the market by 1.5 percent annually.

There are numerous explanations for why investors engage in detrimental behaviors. Shortcomings in human nature, a lack of skill and malfeasance by advisers have all been fingered. There probably is some truth to all of them, but I think investors are tired of the old investment maxims of asset allocation, diversification and buyand-hold. Most people don’t believe, or are encouraged by the investment industry not to believe, that these approaches work. And you can’t blame them.

During the 1990s, large-cap growth stocks, specifically those in the technology sector, outperformed all other market sectors and asset classes. Diversification into anything except technology stocks likely resulted in disappointing performance.

In 2002, when technology stocks imploded, they dragged virtually all other market segments down with them. Diversification within the stock market did not help prevent losses……