Understanding Market Risks: Why Diversification is Our Backbone
I am reaching out to you today because a few clients recently asked me if IBM’s sharp decline over the last two days (falling -36%) was going to hurt their Schwab portfolios.
It is a great question, and the short answer is: No, your portfolio is well-protected.
To understand why, we have to look at how we build and manage your portfolios. In the world of investing, there are three primary levels of stock market risk. Understanding the differences between them—and how we manage them—is key to achieving long-term, stress-free financial success.
1. Total Stock Market Risk (Systemic Risk)
This is the risk inherent to the entire market. When major macroeconomic events occur—such as changes in interest rates, geopolitical shifts, or recessions—the entire stock market can move together.
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How we manage it: Because you cannot "diversify away" total market risk if you own equities, we manage this through asset allocation. By balancing your portfolio with a mix of equities, fixed income, and other non-correlated assets based on your personal risk tolerance, we ensure you are never overly exposed to broad market downturns.
2. Sector Risk
This risk is specific to a particular industry or sector, such as Technology, Healthcare, or Energy. A regulatory change, a supply chain disruption, or a sudden shift in consumer habits can cause an entire sector to decline, even if the rest of the market is doing well.
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How we manage it: We avoid putting "too many eggs in one basket" by spreading your equity exposure across all major sectors of the economy, ensuring that a downturn in one industry does not drag down your entire portfolio.
3. Individual Stock Risk (Idiosyncratic Risk)
This is the risk associated with owning a single company. Corporate scandals, poor earnings reports, executive departures, or product failures can cause a single stock to plummet overnight—independent of how the broader market or sector is performing.
The recent news about IBM is a textbook example of this. Individual stock risk is exactly why we do not invest in single stocks.
The Power of Mathematical Diversification
To see this in action, let's look at the math behind your portfolio.
Instead of buying individual stocks, we utilize broad-market index funds like the SPDR S&P 500 ETF (SPY). IBM makes up only about 0.30% of the SPY. Because we are properly diversified:
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When IBM lost 36% of its value, the SPY only lost 36% of $0.30—which equals a negligible 0.108%.
What could have been a catastrophic financial blow to an investor holding individual IBM stock became nothing more than minor background noise in a well-diversified Schwab portfolio.
Our Commitment to You
Staying properly diversified is the absolute backbone of the Research Financial Strategies success story. It allows us to capture the long-term growth of the global economy while insulating your hard-earned wealth from the volatile swings of individual corporate headlines.
We are continuously monitoring the markets and managing these risks so you don't have to. If you have any questions about your portfolio, or if you would like to discuss your current risk profile, please don't hesitate to reach out.
If you found this explanation helpful, please feel free to share this email with a friend or family member who might benefit from seeing how proper diversification protects their wealth.
Warm regards,
The Research Financial Strategies Team
2273 Research Blvd, Suite 101
Rockville, MD 20850
Office: (301) 294-7500
Source: Yahoo Finance
