Okay, about yesterday... Big stock market drops force financial reporters to crank out the cliches. Back when I did more of this kind of thing, I used to joke with my editors that I should set my word processor to enter a few time-saving stock phrases with just a few keystrokes. Like so: Alt + Shift + F1: "Investors are taking some money off the table." Alt + Shift + F2: "Sellers crowded the exits." Alt + Shift + F3: "Two forces drive the market, fear and greed. Fear was in the driver's seat." Alt + Shift + F4: "Stocks just went on sale." Alt + Shift + F5: "A technical correction on strong fundamentals." Alt + Shift + F6: "It's like somebody somebody blew the dog whistle/snapped their fingers/lit a match." Alt + Shift + F7: "Although today's drop in the Dow seemed large in terms of points, in percentage terms it was only..." Today I've been thinking about another cliche we money journalists use a lot: "zig when the market zags." (By "we" I mean, of course, me.) We say this when we're trying to explain the benefits of diversifying your portfolio across lots of different kinds of assets. If you hold shares in a Fredonian Freedonian duck soup manufacturer, maybe that stock will zig up while your Dell shares are zagging down. Well, yesterday China's stock market zaaaaaaaaged.... and European and U.S. markets got pretty well zagged, too. This is unusual only in degree: Over the past several years, global markets have become more correlated with one another. That's partly because technology and financial innovation make it easier for investors around the world to invest, well, around the world. Maybe it's partly because of hedge funds. (That's another popular cliche these days. Hedge funds also kept me out of Harvard, maxed out my credit cards, and made me miss my deadline last week.) And it's probably also because most assets have been pumped up by the same two global trends: easier money and higher investor risk tolerance. (Time's Justin Fox has a sharp, brief sum-up here.) There are two common rationales for diversification: --Over the long run, you will get a better return with lower risk. My guess is that this is probably still true as regards international diversification, though of course we won't know that for sure until some kind of "long run" is over and we can run the numbers. But recent experience strongly suggests that just buying some European and Japanese blue chips probably isn't enough to diversify away from your S&P 500 index fund. If you want a really low correlation, you'll have to be more adventurous, and should consider assets besides equities. --In the short term, it might keep you from panicking. The idea here is that if you have something in your portfolio going up or holding steady when the U.S. market falls, you won't be so tempted to sell in a frantic effort to hold back your losses. This is a rationale cited more often by the brokers and financial planners I talk to, and not so much by economists. I don't know if there's any real proof that this actually works, even when you get the zig/zag effect. (I'd be delighted to hear from you if you have some.) But diversification clearly didn't protect your sanity yesterday. If you had 10% of your portfolio invested in an Asian emerging markets fund yesterday, I'm pretty sure you felt worse than the rest of us. As another Wall Street cliche goes, diversification only works when you don't need it. If you want to avoid panic, here's a better idea: Set up a well diversified portfolio that suits your risk profile and then do your best to ignore the thing. (You can rebalance once a year or so.) Make it rule than when the market drops more than, say, 200 points, that's the one day you will absolutlely NOT check your account.