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When markets climb into record territory, Wall Street-types start talking up risk management strategies.  Here are three – and why they’re suspect:

  1. Dollar-Cost-Averaging – buying a position bits at a time, to “average” the overall cost basis of the security.  Problem:  money on the sideline waiting to come in is earning nothing.
  2. Mutual Funds – are promoted as the ultimate risk management tool.  Problem is you’re paying twice; your broker who recommends them – and the mutual fund manager who manages the money.  They’re often not that diversified – they’re tax-inefficient – and capturing dividends requires great timing.
  3. Diversification – buying securities with differing risk profiles so if one tanks – it doesn’t take the whole portfolio down.  Problem:  Spreading risk necessarily means compromising upside potential and overall returns.

Diversification sounds like a good idea – but there’s only one thing it does for sure:  drive fee and commission income into the Wall Street machine.

Does it effectively mitigate risk?  Like any form of insurance – you won’t know until you need it (experience a down market).

The more fundamental issue is that diversification is only relevant in a risky environment.  If there were no risk in the first place, diversification would be unnecessary – and a waste of though energy.

Is “risk-free” investing possible?  Yes.  A relatively new growth strategy called equity indexing, captures much of the market’s upside movement, while eliminating all of its downside risk.