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Personal Finance: Investments Suffer on 'Cruise Control'

by on April 17, 2011 6:00 AM

A few years ago, modern portfolio theory was the standard in the investment business. Place your money in a diversified portfolio of a variety of investment vehicles and relax. Further, because you were diversified, you didn’t need to pay close attention to your holdings and neither did your financial advisor. For the most part, your financial advisor was focused on attracting more assets to manage, rather than tracking the results for your holdings. Diversification was designed to have winners offset losers and reduce the volatility of any one investment. The whole of your portfolio was supposed to grow modestly with few if any serious declines. In other words, diversification was supposed to place your money in investments whose price action was not correlated. The assumption by the entire investment industry was that investment price correlation was a constant over market cycles. If you have followed me this far, you know the punch line is coming.

Price correlation between investments is not a constant as had been assumed. 

It is variable over market cycles. Recent studies that were made to explain the disaster of the 2008-2009 investment markets indicated that diversification was a failure as an investment strategy. Those investments that had low price correlation in rising markets had near equal correlation in declining markets. In other words, diversification reduced your returns when stock prices rose and didn’t protect your portfolio from losses when the stock market declined.

The pain caused by this misunderstanding caught many so-called financial advisors by surprise. Many clients felt as if they had been let down by their financial professionals. However, as I mentioned, many financial professionals are actually asset gatherers and not studious portfolio managers. True portfolio management requires that close attention be paid to your existing clients’ holdings as a full time endeavor.

To say that there is a disconnect between the expectations of investors and their financial professionals is probably putting it mildly. Of course, the end result in the investors’ portfolios tells the real story.

We have learned three things from the most recent financial meltdown:

1.) You cannot assume that your portfolio strategy (based on great investment theories) is going to work in the next investment cycle.

2.) Since we cannot anticipate the future with certainty, investors and their professionals must pay constant attention to their holdings, always being ready to change investment as the market prices dictate.

3.) The explanation of what happened always comes after the event, and never anticipates the event in such a way as to warn you to make changes in your investments. 

Our most recent explanation is that the price correlations of investments are not constants, but variables depending at least in part on the cycles in the investment markets. More simply, there is no substitute for paying close attention to your investments, as investments do not generally perform well on cruise control.

The other day someone explained the devastation his portfolio took in 2008. He told me he unavoidably missed his broker’s call. What’s worse, he forgot to return the call and ultimately rode the market to the bottom, when he eventually sold based on emotion rather than careful analysis. 


Generally, you need to make changes in your portfolio before disaster has become part of your investment lexicon. Even when we pay attention and make appropriate moves, we are not without mistakes. Good portfolio management is part paying attention, part making changes and part limiting damage caused by making mistakes. 

Mistakes are going to happen. Investment disaster is what happens when mistakes are allowed to continue unattended and without corrective action.

Dan Nestlerode was previously the Director of Research and Portfolio Management at Nestlerode & Loy Investment Advisors in State College. He retired in 2015 after 50 years in the investment business. A graduate of Penn State University, Nestlerode became an investment advisor in 1965. He can be reached at [email protected]
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