Diversification: Why Seeing Red Can be a Good Thing…

New Reader? Get free regular updates from Can I Retire Yet? on saving, investing, retiring, and retirement income. New articles about twice/month. Join more than 14,000 subscribers. Unsubscribe at any time:

Can watching your investments go down ever be a good thing? To answer that, you need to know a little about my weekly investing routine.…

For years I’ve tracked my investment portfolio on a My Yahoo page. It doesn’t take much space: currently just nine mutual funds and ETFs make up the entire portfolio across all our taxable and retirement accounts.

Though investing has long been an interest, I don’t hang on the market’s every move. I update my portfolio value once a week, on Fridays. And I take a more in-depth look, computing asset allocations and net worth, quarterly.

But, out of habit and curiosity, I do often check prices after the daily market closing. Though there is no long-term impact on my portfolio, it is interesting to note whether the financial world was feeling optimistic or pessimistic that day.

Yahoo’s portfolio widget has a familiar color convention: If your holding went up for the day, its percent change is displayed in green. And if it went down for the day, the number is displayed in red.

My portfolio has always been roughly split down the middle between stocks and bonds, with some decent allocations to cash, commodities, and real estate. So it’s a diverse lot. Each quarter, as mentioned, I crunch the numbers to know my exact asset allocation. But there isn’t much I don’t already know, subconsciously, from seeing those green and red numbers every day. Over time, here’s what I’ve observed.…

When the world and the financial markets are operating at the extremes, there are days when all my holdings are either up (green) or down (red). But given the diversity of the portfolio, those days are rather rare. More often I see a mixture of colors. And then I know that all is well. Not that I’m excited about some of my investments being down on any given day. But more important than the movement in price is the simple confirmation that my portfolio is made up of uncorrelated assets.

And that’s how it should be. Over long periods of time you expect most of your investments to go up. But, in the meantime, when something inevitably goes down (red), you want something else to go up (green), to compensate. You could achieve all green some of the time by making risky bets on whatever asset classes are currently in favor. Or you could achieve an illusory all green all of the time, by holding just cash — but you’d be trounced by inflation in the long run.

Much better to diversify. So while I’m happy on those days when I see all green, I am content, as a diversified passive index investor, on those days when I see a mix of colors. Because then I know my portfolio is behaving as designed.

Yahoo doesn’t use the color yellow, as far as I can tell, but it’s never far from mind. Yellow is the traditional color for caution. And a wise investor is ever cautious. Investing is not a speed race, but neither is it a cakewalk. There are clear dangers, and definite winners and losers, over both the short and long hauls.

A wise investor isn’t reckless, or paralyzed by inaction, but proceeds steadily with caution. In the end, that investor knows that a mix of daily investing results is best, because it represents the heartbeat of a well-diversified portfolio at work.