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Diversification and Consolidation: Not Just Investing Jargon

Diversification and consolidation may sound like basic investment jargon (what "ation" word doesn't?), but they're actually two principles you might want to consider on your financial journey. One may help you manage risk. The other may make it easier to manage your goals.

Manage Risk With Diversification

Diversification is the practice of spreading your money among different asset classes—stocks, bonds and cash—to help manage risk. By balancing your portfolio, you can potentially offset declines in one area with gains in another. In addition, having a variety of asset classes may also help in recovering from a loss.

Returns During Dot-Com Crash, April 2002 to September 2002

Source: Morningstar. Technology sector represented by the S&P 500® Information Technology Index. Diversified portfolios are represented by Morningstar category averages as follows: Aggressive Risk—Allocation 70% to 85% Equity; Moderate Risk—Allocation 50% to 70% Equity; Conservative Risk—Allocation 30% to 50% Equity.

At the heart of diversification is the idea that you should have uncorrelated investments. Correlation (another "ation" word) measures the degree to which two securities move in relation to one another, and it matters in your portfolio. The goal is to have uncorrelated investments that don't react the same way to any one market condition.

Portfolios with more exposures to other sectors and assets types still declined, but recovered from losses much sooner.

Correlation Can Be Sneaky

Investors may not always recognize when they have highly correlated investments. For example, if you own a large cap growth stock fund plus an S&P 500® Index fund, you could be investing in exactly the same companies. Or, your investments may be highly correlated if your assets start acting like one another. Correlation can change over time, and two assets that weren't correlated in the past may start moving in the same direction.

Volatile markets can be an important time to think about correlation because stocks can begin moving even more in tandem, even among different market sectors. In addition, if economic forces cause companies to perform poorly, they may also be unable to meet their debt obligations, which may affect bonds too.

Careful Portfolio Construction Makes It Work

A carefully constructed portfolio is critical to diversification. While some investors like to do it on their own, a financial professional can also help you determine a diversification and asset allocation strategy (how much of each kind of investment) that matches your needs, how long you have to invest and how you feel about risk.

Diversification and Consolidation Intersect

And that leads us to consolidation. What do diversification and consolidation have to do with one another? A lot, actually. Consolidating accounts in one place, or a couple of places, may give you a more accurate view of your overall financial condition. It may also help you judge better whether you are diversified properly.

Here's one last thing to note about diversification: Investing your money with different financial firms may not result in a diversified portfolio. Variations in asset classes at different firms won't help if your investments all act the same when markets move. Having investments spread out among wealth management firms may make it difficult to determine if your diversification strategy is effectively reducing risk.

Investing your money with different financial firms is not the same as diversification.

There also may be financial planning and cost implications from keeping your money separated. While it sounds smart to "not have all your eggs in one basket," it may be less efficient and could cost you more in fees. And if you're using planning services from different firms, you might end up with "too many cooks in the kitchen" and a fragmented financial plan.

Potentially better diversification. Big picture financial planning. Fewer accounts to track. Why aren't more people consolidating? Let's be honest: Even if you decide it's the right course for you, moving accounts sounds time-consuming and difficult. Plus, it takes a high level of trust to let one firm or consultant handle the bulk of your investments.

Start with Baby Steps

Maybe you're not ready to take the full consolidation plunge. You could also consider small steps, such as consolidating retirement accounts from former employers with your other retirement savings. And if you work with a firm that's worth its weight, it'll take the lead in transferring your assets—or do it for you with minimal demands on your time.

At the very least, if you work with a financial advisor, he or she should have a complete view of all your holdings in order to give you the most effective diversification and financial plan for the path forward.

Your Finances Are Too Important for a Fragmented Plan

Talk to a consultant about your diversification strategy or to find out if consolidation is right for you. We’re here for both.

Before you move your money, check with current providers about potential consequences, including taxes, penalties, charges or the other companies' fees for liquidating or transferring your assets.

Diversification does not assure a profit nor does it protect against loss of principal.

The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.

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