Diversify Mutual Holdings To Cushion Shocks
If and when mutual funds come to the day of reckoning many skeptics have so long predicted, they will almost surely stand or fall on the strength of a single investment virtue - diversification.
As long as the funds and their shareholders collectively practice diversification the way it is supposed to be done, it should serve as a strong shock absorber against bear markets, recession, inflation or any other of the known financial perils.
It won’t shield investors completely from losses. But it should prevent the boom in funds from giving way to a bust, as has happened in the past.
From the days of the first mutual funds in this country more than 70 years ago, diversification has been the system’s foundation.
The trouble is, diversification, like a lot of other cardinal virtues, isn’t always observed by the book. In good times particularly it can be hard to stay with a full commitment to diversification when bigger risk-takers are making fortunes by focusing on hot spots like, say, technology stocks.
Individual fund investors get a measure of diversification from any broadly organized fund they own. On top of that, they can custom-design their own portfolios to whatever degree of diversification they desire by mixing and matching several funds of different types.
If they want further protection, they can buy a precious metals fund, or a real estate fund, or a money fund that buys nothing but ultra-safe Treasury bills. They can do all this without leaving the fund industry.
The funds and all their investors who stay reasonably diversified are set up to withstand some pretty severe shocks that originate in the markets - in contrast to the 1960s, when go-go funds placing high-risk bets in the stock market were just about the whole story.
So, logically, if the current fund boom is going to collapse the way the one in the ‘60s did, the problem will have to come from some source other than a shift in market conditions. Either that, or the funds and their clientele will have to stray too far away from the precept of diversification.