World stock markets have been increasingly volatile this summer. Returns for market indices have turned negative and the S&P 500 suffered its first 10% correction since 2012. Because of this, I have received several message in my inbox that ponder what do in this environment. A couple of the titles were "What you should do in volatile and uncertain markets" and "When market conditions become volatile, how will you react?" The two main strategies that they suggest are 1) stay the course and 2) a diversified portfolio is the best way to be positioned. While this seems sensible in a bull market cycle, these two strategies do not work in a bear market cycle. Therefore, the most important question is not what to do in a volatile market, but is this a bear market?
“Wide diversification is only required when investors do not understand what they are doing.”
– Warren Buffett
We've all heard the old idiom, "Don't put all your eggs in one basket." For more than five decades, portfolio diversification has been considered a basic building block of any investment portfolio -- with the critical function of reducing risk and dampening volatility. There is a trend toward what may be deemed over-diversification. Should you own a stock in your portfolio to dampen volatility or because of positive underlying fundamentals of a company?
Last year in February, I wrote a blog post entitled "A lesson from Warren Buffett on buying fear." The S&P 500 was down 5% from its high and the negative headlines focused on slowing global growth and worries about the Fed tapering. If you had bought on that day, you would be up over 20% on your investment!
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