A Different Way to Diversify

by Marc Bastow | February 12, 2013 11:40 am

A Different Way to Diversify

It’s refreshing when a new way to plan for retirement comes along because such ideas are an opportunity to reconsider our assumptions and take stock of how our own portfolios are constructed.

Take diversification, which broadly speaking is all about putting your money to work across a wide range of assets in an effort to avoid having everything stuck in the same bucket in the event it starts springing leaks. That would be a very bad plan.

But there’s more than one way to diversify. The Wall Street Journal’s Jason Zweig has even coined another name for diversity, “differsification,”[1] which advocates spreading bets across a set of buckets that reflect what you think is coming next in the economy: expansion, recession, inflation or deflation.

Interesting. In this approach, you’re no longer trying to balance risks across sectors and assets, hoping to offset a drop in one holding with a rise in another holding. Here you’re trying to deploy your assets to hedge or take advantage of economic booms or busts.

So what might such a portfolio look like? Let’s look at each “bucket” and work one out.

1. Deflation buckets look to protect you when prices are falling. So, this portfolio should contain a mix of dividend stocks and bonds, although that might sound counterintuitive. But think about it: Dividend stocks should continue to pay out cash (but not always, of course) to counteract, to some extent at least, market losses. And while bond yields may stink, you can look to price appreciation, since yield and price move in opposite directions. Phillip Moeller in U.S. News[2] makes a great case for both here, so why not look to the usual dividend-paying suspects like ExxonMobil (NYSE:XOM[3]), Johnson & Johnson (NYSE:JNJ[4]) and Coca-Cola (NYSE:KO[5])? As for bonds, stick to U.S. government issues or municipal bonds, which have gotten an undeserved bad rap[6].

2. Inflation buckets aim to help you out when the cost of living is rising faster than expected. For most retirement portfolios that should mean Treasury Inflation Protected Securities (TIPS[7]). If inflation runs higher than the roughly 2% to 2.5% inflation rate that Vanguard’s Gemma Wright-Gasparius, among others, is projecting over the next 10 years, TIPS should guard against loss by boosting the rate of return on that portfolio. A fund such as the Vanguard Inflation-Protected Securities Fund (MUTF:VIPSX[8]) is a good way to hedge inflation risk. You can also buy TIPS through the TreasuryDirect system in $100 increments, with 5- 10- or 20-year maturities.

3. Recession buckets are tough because you need assets to counteract the effect of a slowing economy. Like the Deflation bucket, bonds are again your best bet because lower interest rates boost bond prices. Again, bond funds and ETFs can help you spread this risk out a little bit. High-quality intermediate-term bonds are a good start, with iShares Core Total U.S. Bond Market ETF (NYSE:AGG[9]) a solid player. Just over 50% of the bonds it holds mature in 1 to 10 years.

4. Expansion buckets are, of course, the best of all worlds since the idea is to take advantage of a growing, or even booming, economy. How about real estate investment trusts[10] like these three? If played correctly (read: cautiously), commodities like oil and gas can fit very well into this bucket. And of course stocks, particularly growth stocks with some history of dividend growth. Some prime examples: Disney (NYSE:DIS[11]), which is up nearly 70%[12] over the past five years, or Home Depot (NYSE:HD[13]), up over 137% over the same time.

Whatever way you come up with to play this new riff on retirement planning, it’s nice to rethink an old model and take a fresh look at your portfolio. Have at it!

Marc Bastow is an Assistant Editor at InvestorPlace.com. As of this writing he is long XOM and JNJ.

  1. “differsification,”: http://online.wsj.com/article/SB10001424127887324906004578292200253111008.html
  2. Phillip Moeller in U.S. News: http://money.usnews.com/money/blogs/the-best-life/2012/02/01/how-to-prepare-for-a-deflationary-world
  3. XOM: http://studio-5.financialcontent.com/investplace/quote?Symbol=XOM
  4. JNJ: http://studio-5.financialcontent.com/investplace/quote?Symbol=JNJ
  5. KO: http://studio-5.financialcontent.com/investplace/quote?Symbol=KO
  6. an undeserved bad rap: http://investorplace.com/2012/12/making-a-case-for-muni-bonds-is-simple-risk-and-return-xom-msft-adp-jnj-pg-hpq/
  7. TIPS: http://www.investopedia.com/terms/t/tips.asp#axzz2KbOgpkXb
  8. VIPSX: http://studio-5.financialcontent.com/investplace/quote?Symbol=VIPSX
  9. AGG: http://studio-5.financialcontent.com/investplace/quote?Symbol=AGG
  10. real estate investment trusts: http://investorplace.com/2012/08/tanger-reit-worth-the-shopping-trip-skt-spg-uba/
  11. DIS: http://studio-5.financialcontent.com/investplace/quote?Symbol=DIS
  12. up nearly 70%: http://investorplace.com/2012/11/a-mouse-size-step-for-disneys-dividend/
  13. HD: http://studio-5.financialcontent.com/investplace/quote?Symbol=HD

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