Diversification and Asset Allocation in Volatile Markets

Brexit: A Lesson in Diversification and Asset Allocation

Last week, when United Kingdom voters decided to leave the European Union (EU), known as “Brexit,” stocks took quite a tumble. International stocks – particularly those of companies based in the U.K. – fell especially hard.

With all that has happened, you might be wondering whether is it time to dump (or at least scale back) your international stocks.

“If you are investing for the long-haul, shedding international holdings probably doesn’t make much sense,” said Joe Correnti, senior vice president of brokerage product at Scottrade. “While the vote in the U.K. has led to some volatility in the market, in fact this appears to be the most significant two-day disruption the market has seen, we continue to believe the markets will bounce back, and recent events will likely be viewed as an opportunity.”

Investors can take comfort in the fact that Friday’s stock market decline was around the average for all market shocks since World War II, according to S&P Global Market Intelligence.

“Market shocks, in general, tend to be short and shallow as investors quickly come to the conclusion that the event will not throw the U.S., or the world, into recession,” it said in a note to clients Monday, although the organization noted that Brexit has the potential to negatively affect economic growth in both the U.K. and the EU at large, potentially halting a quick bounce back.

The Effects of Brexit on The Economy … And Your Portfolio

The effect of Brexit on the global economy is far from determined. Much of that will depend on factors such as the terms of the U.K.’s exit from the EU, the direction a new prime minister will take country (current U.K. Prime Minister David Cameron announced his resignation after the vote and looks to leave office by October) and whether other countries in the EU will also feel compelled to break off.

“Uncertainty typically causes the greatest market volatility,” Correnti said. “Until the outlook for the U.K. and EU economy is further understood over time, we would expect additional volatility for both U.S. and global markets.”

The significance of the U.K. in world affairs has played an important part in the global markets. According the International Monetary Fund, the U.K. is the fifth-largest economy in the world, with a gross domestic product of about $2.9 trillion. So while companies that will experience the most direct effects of Brexit may be U.K.-based companies, the size of the U.K. economy means its affairs may have an impact on the global economy at large – and the uncertainty of its impact is what is causing the volatility.

The Importance of Diversification

For most investors, the Brexit takeaway emphasizes the importance of diversification.  

 “When owning equities, it’s important for long-term investors to maintain variety,” Correnti said. “So while international stocks, particularly those with heavy U.K.-ties, were hit hard, the impact on U.S. stocks was much less.

“However, there may be other events where international stocks will do better than U.S. companies.  By maintaining a diversified portfolio, you should be better equipped to handle the ups and downs of the markets rather than if you place all of your eggs in one basket.”

An Opportunity to Rebalance

In addition to maintaining a diversified portfolio, the Brexit aftermath may be an opportune time to look at the mix of assets in your portfolio.  Let’s assume that your target portfolio consists of 60% equities and 40% fixed income. The sharp drop in equities could have you holding a larger portion of your portfolio in bonds.

If you want to keep your 60-40 balance, you have one of two options: You can either consider this episode an opportunity to rebalance your portfolio, or you can wait to see if your portfolio returns back to normal relatively quickly. You should take into account factors such as your time horizon and risk tolerance to determine your best course of action.

For questions regarding your portfolio, or to schedule an appointment for a portfolio review, please contact your local Scottrade® team  or your investment consultant.

To get more information about portfolio allocation, check out Rebalancing: Keeping Your Portfolio in Check and 8 Tools to Help Get Your Portfolio on Track.

The information and content provided is for informational and/or educational purposes only. The information presented or discussed is not, and should not be considered, a recommendation or an offer of, or solicitation of an offer by, Scottrade or its affiliates to buy, sell or hold any security or other financial product, or an endorsement or affirmation of any specific investment strategy. You are fully responsible for your investment decisions. Your choice to engage in a particular investment or investment strategy should be based solely on your own research and evaluation of the risks involved, your financial circumstances, and your investment objectives. Scottrade, Inc. and its affiliates are not offering or providing, and will not offer or provide, any advice, opinion or recommendation of the suitability, value or profitability of any particular investment or investment strategy.

Keep in mind that while diversification may help spread risk, it does not assure a profit, or protect against loss, in a down market.

International investing can involve substantial risks and is not suitable for all investors. Risks include changes in currency exchange rates; political, economic and social events; potential for illiquid markets; less information; reliance on foreign legal remedies; and different market structures and operations. Investors should fully research any security or strategy before making an investment decision.

Bonds involve risks including, but not limited to interest rate risk, reinvestment risk, inflation risk, call risk, liquidity risk, credit risk, market risk, default risk, event risk, and a risk of loss of principal. New issue offerings are sold by prospectus or offering circular available at www.scottrade.com. Investors should read these carefully.

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