Deversification and Asset Classes Cycles

When constructing your investment portfolio make sure that you include assets from different classes. In this way you will be able to enjoy the positive effects of diversification.

Different types of assets go through different cycles as regards their performance and prices. Therefore, random changes in the performance of either bonds or stocks can be observed. These patterns of movement can be quite unpredictable, guided by market conditions and many unforeseen factors. However, in order to insure against losses due to such volatilities diversification is recommended.

Generally, there are two major classes of assets - stocks and bonds. Even though often these two has acted in an opposite direction, the trend has not always been this way. Many examples can be provided from historical records.

It has been proven that all asset-class markets go through one and the same cycle regarding their prices - an up, flat level, and a fall. Therefore, many financial experts claim that identifying the current condition of the particular asset class may lead to the prediction of the next stage in the cycle and thus take advantage of it. This do holds some validity, but what makes predictions difficult is the exact pace of the movement from one cycle to the other. Thus, it is difficult to predict the end of one cycle and the beginning of the next.

Another way for basing investment decisions different from predicting cycles, is the examination of past performances. However, this tactic may result in the purchase of an asset class that is no longer profitable. Additionally, basing your investment on past performance may result in the negative effect of the trend turning in the opposite direction, which was not experienced during the past periods on which you have based your decision. Such was the case during the long persisting bull market of the 1990s. This period was followed by a continuing from 2000 to 2002 bear market. After this, the stock market experienced sudden recovery.

Subclasses of assets also experience cycles. That is why subclasses within asset classes can also support diversification in your investment portfolio. Therefore, you can use asset subclasses as a tool to further diversify your portfolio.

Finally, since asset classes' cycles cannot be clearly predicted, diversification should be implemented. Investments in different classes of assets should be pursued since they go in different directions at different speeds.

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