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The [Negative] Short-Term Implications of Investment Portfolio Diversification

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Delving Deeper into Asset Allocation

By Lon Jefferies MBA CFP® CMP®

Lon JeffriesAsset allocation is one of the key factors contributing to long-term investment success.

When designing a portfolio that represents their risk tolerance, investors should be aware that a portfolio that is 50% stocks is likely to obtain approximately half of the gain when the market advances but suffer only half the loss when the market declines.

This general principle frequently holds true over extended investing cycles, but can waiver during shorter holding periods.

Case Model

For example, a fairly typical physician client of mine who has a 50% stock, 50% bond portfolio has obtained a return of 4.62% over the last 12 months, while the S&P 500 has obtained a return of 14.31% over the same time period (as of 10/30/14).

An investor expecting to obtain half the return of the index would anticipate a return of 7.15%, and by this measuring stick, has underperformed the market by over 2.50% during the last year.

What caused this differential?


The issue resides in how we define “the market.” In this example, we use the S&P 500 index as a measure for how the market as a whole is performing. As you may know, the S&P 500 (and the Dow Jones Industrial Average, for that matter) consists solely of large company U.S. stocks.

Of course, a diversified portfolio owns a mixture of large, mid, and small cap U.S. stocks, as well as international and emerging market equities. Consequently, comparing the performance of a basket of only large cap stocks to the performance of a diversified portfolio made up of a variety of different asset classes isn’t an apples-to-apples comparison.




Frequently, the diversified portfolio will outperform the non-diversified large cap index because several of the components of the diversified portfolio will obtain higher returns than those achieved by large cap holdings.

However, the past 12 months has been a case where a diversified portfolio underperformed the large cap index because large cap stocks were the best performing asset class over the time period. In fact, over the last twelve months, there has been a direct correlation between company size and stock performance (as of 10/30/14):

  • Large Cap Stocks (S&P 500): 14.92%
  • Mid Cap Stocks (Russell Mid Cap): 11.08%
  • Small Cap Stocks (Russell 2000): 4.45%
  • International Stocks (Dow Jones Developed Markets): -1.05%
  • Emerging Market Stocks (iShares MSCI Emerging Markets): -1.04%

Since large cap stocks were the best performing element of a diversified portfolio over the last 12 months, in retrospect, an investor would have obtained a superior return by owning only large cap stocks during the period as opposed to owning a diversified mix of different equities. Does this mean owning only large cap stocks rather than a diversified portfolio is the best investment approach going forward? Of course not.

Year after year, we don’t know which asset category will provide the best return and a diversified portfolio ensures we have exposure to each year’s big winner. Additionally, although large caps were this year’s winner, they could easily be next year’s big loser, and a diversified portfolio ensures we don’t have all our investment eggs in one basket.

Financial Planning MDs 2015

Comprehensive Financial Planning Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™


Don’t be overly concerned if your diversified portfolio is underperforming a non-diversified benchmark over a short period of time. As always, long-term results should be more heavily weighted than short-term swings, and having a diversified portfolio is likely to maximize the probability of coming out ahead over an extended period.


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2 Responses

  1. Lon,

    In my twenty years of medical practice, and 15 years as a financial advisor, I observed that physicians are particularly disadvantaged when it comes to anything regarding finance. Most doctors and healthcare providers have enough on their mind practicing their specialty and keeping up with technology, compliance and practice trends; that planning for their financial future is often forgotten. Financial planning and good investment practices require a solid background of how companies work in the “real world”, and an awareness of how they function within the economy. These economic essentials are vital to understanding business, as are the principles like budgeting, risk management, cash flow analysis, fiscal benchmarking and rudimentary accounting that are presented in this book. Yet, physicians have economic concerns that are different than most people.

    • First, they enter the workforce about a decade later than their non-medical contemporaries, leaving fewer productive years and beginning with enormous medical school debt levels.
    • Second, they tend to marry and have children later in life, often postponing their offspring’s educational funding and their own retirement planning.
    • Third, family members often erroneously think of them as affluent, seeking their financial assistance.
    • Fourth, health reform and managed care has reduced remuneration just as governmental scrutiny has burdened practices with costly IT, privacy rules and PP-ACA regulations.
    • Fifth, a three decades long bull market in bonds and equities is over and if the current “new-normal” prevails – meaning a 4.5% real annualized rate of return on equities and a 1.5% real rate on bonds – wealth accumulation for all will be reduced going forward.
    • Sixth, physicians lack financial management expertise, especially after changes in the tax code, electronic connectivity initiatives, various new practice risks, healthcare reform and the PP-ACA, etc.

    Accordingly, informed advice from a medically focused advisor, or Certified Medical Planner™, is vital. And, construction of a comprehensive financial plan, with an Investment Policy Statement [IPS], that acknowledges the impact of health reform and the PP-ACA is now almost an essential requirement for success.

    Traditionally, a well-conceived financial plan consisted of tax reduction planning, various insurance matters, investing, and portfolio management, retirement and estate planning. For modern physicians of the Health 2.0 Era however, these disciplines, and many more, must be incorporated into the mix in a managerially and psychologically sound manner not counterproductive to individual components of the plan. As a sobering caveat, the integration of these protean disciplines is no longer an academic luxury, but a pragmatic survival imperative recognized by the contemporary Certified Medical Planner™ and corporate sponsors at the Institute of Medical Business Advisors, Inc. The following example is illustrative.

    • Reflect a moment on medical colleagues willing to securitize their practices a few years later, and cash out to Wall Street servitude for riches not rightly deserved. Where are firms such as MedPartners, Phycor, FPA, Coastal Healthcare, and a host of others, now? A recent survey of the Cain Brothers Physician Practice Management Corporation Index of publicly traded PPMCs revealed a market capital loss of more than 99%, since inception. Would niche educated and physician-focused financial advisors [The Certified Medical Planner™ professional designation did not yet exist] have been able to avoid this calamity?

    Want more proof this book is sorely needed? Just remember the sub-prime mortgage crisis of 2008, recognized and acted upon almost exclusively by contributor Michael Burry MD. And, don’t forget the financial impact of the Patient Protection and Affordable Care Act [PP-ACA] that is finally rolling out thru 2016; it is both pervasive and invasive to virtually all Americans and medical providers, with detractors and advocates on both sides.

    Of course, financial planning and personal economics is always challenging because chaos is the constant element of life. It is even more so for physicians, who face the reality that medical care is becoming a commodity in the United States. Even the late Dr. C. Everett Koop MD opined that although Americans have no constitutional right to health care, the perception of one is so strong that the country is likely to have a socialized system sometime in the near future. With our national agenda dominated by terrorism, the threat of biological and chemical warfare, bioengineering and the ethical concerns of human cloning, electronic medical records, mobile health and ICD-10, technological advancements, para-professional practitioners and health network hacking and cyber-insecurity, it is unlikely that significant governmental financial assistance to physicians will take place anytime soon. In fact, many opine that over the next few years, reimbursement rates set by the Center for Medicare and Medicaid Services (CMS) could further erode by another 15-20% after full implementation of the PP-ACA.

    Individual provider and personal circumstances also change as the domestic healthcare milieu is in constant flux. Comprehensive financial planning for medical professionals is truly a journey and not a destiny. Progress toward personal and practice goals are the objective; not some composite index, annualized rate of return, or stock price.

    Therefore, for physicians and health professionals to survive, economic and financial competency is required in the new order. Hopefully, the requisite material to begin the task has been codified for them, and their advisors, in COMPREHENSIVE FINANCIAL PLANNING STRATEGIES FOR DOCTORS AND ADVISORS [Best Practices from Leading Consultants and Certified Medical Planners™].

    And so, if there is some financial issue not specifically addressed in this book, fear not! The sub-niche topic you seek will likely be covered in a future iMBA Inc textbook or online at the Medical Executive-Post [www.MedicalExecutivePost.com]. Join our more than seven hundred fifty thousand readers and subscribers, today. A subscription is fast, free and secure.

    Dr. David Edward Marcinko MBA CMP™
    [Certified Medical Planner™]


  2. Diversification Strikes Back

    Let’s revisit the investment year of 2014:

    – S&P 500 (large cap stocks): +13.69%
    – Russell 2000 (small cap stocks): +4.89%
    – iShares MSCI EAFE (international stocks): -7.09%

    These returns caused a lot of confusion and frustration among investors. A well diversified investor who allocated a third of their portfolio into each of these asset categories achieved a return of only 3.83% during the year.

    Meanwhile, most people use only large cap indexes such as the Dow Jones Industrial Average, the NASDAQ, or the S&P 500 as a metric for how markets are performing.

    Consequently, after hearing how these large cap indexes obtained double digits returns during the year, it was challenging for some investors to comprehend why their portfolios obtained returns of only a fraction of what these well known indexes earned.

    In fact, some investors started to wonder why they own any investments other than large cap U.S. stocks.


    Lon Jefferies MBA CFP™


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