There’s nothing better than catching up with market thinking and returning to old classics when on holiday; that’s what we all love to do, after all. Mark Twain couldn’t say it better: making our vocation our vacation is the secret to success. Turns out, Mark Twain was a prescient investor. We should have listened to him when we debated whether the inflation spike would be short-lived or long-lasting: “Buy land, they’re not making it anymore”. And, with things out there so uncertain, his insight seems to resonate now too: “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so”. So how do we deal with uncertain outcomes, shifting conviction levels and, generally, with a world that’s inherently unstable? The answer is portfolio diversification. Hear me out.
Portfolio diversification is the practice of spreading your investments around so that you limit your exposure to any one type of asset. The idea is that they do not have the same return drivers – each will perform differently at different times.
Why stick to one country when you can have the world? Different things could drive different stock markets around the world. And, more often than not, the best performing stock market tends to change from year to year.
Similarly, why stick to stocks when you can also access other asset classes? Cash, bonds, funds, and many other investments, each have different return and risk characteristics that can help seize different opportunities while mitigating different risks.
Coined in the early 1600s by the author of Don Quixote, Miguel de Cervantes, the saying “Don’t put all your eggs in one basket” has become a valuable metaphor for explaining how you could manage your risk when investing.
If you invest in just one company, you rely solely on it to do well. And, as we know, various factors – such as company and sector news, government and central bank events and decisions, and wider economic trends – can cause the markets to go up and down.
Not putting all your eggs in one basket means that, by investing in a range of assets, you can balance the poorly performing investments with ones that are doing better, and local events (say, Brexit or Russia’s invasion of Ukraine) could have less of an impact. Diversification can help reduce the volatility of portfolios.
One of the keys to successful investing is learning how to balance one’s comfort level with risk against the time horizon of the chosen investment strategy. Invest too conservatively and the growth rate of your investments won’t keep pace with inflation. Invest too aggressively and you could excessively expose yourself to market volatility, which could erode the value of your assets to an extent that makes recouping your losses difficult.
Think about a goal 20 or 30 years away, like retirement. Because your time horizon is long, you may be willing to take on additional risk in pursuit of long-term growth, assuming that you’ll usually have time to regain lost ground following a short-term market decline. In that case, a higher exposure to stocks may be appropriate.
But here’s where your risk tolerance becomes a factor. Regardless of your time horizon, you should only take on a level of risk with which you’re comfortable. So, if you’re relatively risk-averse, you may want to consider a more balanced portfolio including high-quality fixed income assets – even if you’re saving for a long-term goal.
The first thing you’re taught when playing sport is: don’t chase the ball, stick to your position. Go to any kids’ match, and you’ll see all the players ignoring this advice. They chase the ball and run around, leaving no defence in place. If your investments are all doing the same thing, your portfolio probably lacks a defence.
That’s where the danger is. Investing isn’t about picking winners. Of course, that plays a role, but it’s not easy to spot the star player. Instead, building a good team with all players working well together is something you can apply yourself to.
If we could fully control how investments performed, the world would be a vastly different place. We can’t. But we can spread our money to be ready for the unavoidable unpredictability that’s out there.
No strategy can guarantee that the value of a portfolio increases without occasional setbacks, as no one can make assets appreciate and markets trend higher. It might feel uncomfortable to put hard-earned money into areas that aren’t doing well – but when things improve, and eventually they do, you’re more likely to be in the right place at the right time by applying a portfolio diversification strategy.
Those who stay invested over the long run in a well-diversified portfolio tend to do better than those who try to profit from turning points in the market. And that’s what we do.
Of course, this doesn’t mean investors shouldn’t take advantage of opportunities offered by the market and instead invest once and wait. So, we tilt our portfolios according to whether we believe valuations are attractive, the key market technicals make sense, and the catalysts we identified are playing out (or not, therefore requiring an adjustment to our investment strategy).
While our outlook lays out our base case for the next 6-12 months, we’re not married to pre-set conclusions. We care more about how we arrive at those conclusions: the mechanics – our understanding of the cause-effect logic behind them. As things inevitably change, the same mechanics could point to different conclusions over time.
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