Your Investments Should Look Like a Batting Line UpSubmitted by Castlebar Asset Management on August 20th, 2015
One thing I have learned is that diversification can be an easy concept to explain to clients but difficult for them to embrace. Diversification is typically presented using the analogy of holding all of your eggs in one basket. This is far too simple. I think it is better explained like a baseball batting order.
A baseball manager has nine players who get to bat. There are many moving pieces in a baseball line up and they interact to give a team their best possible outcome over a season. At any given time some of their players will be experiencing a hot streak while others will be in the midst of a slump. The same can be said about the investments in a diversified portfolio. We’ll use a portfolio of 80% US Stocks and 20% international stocks as our example. Some years both markets will rise in tandem but over shorter periods of time one will perform better than the other. You won’t be able to predict with great accuracy when one market will outperform just like it is hard to predict when a hitter will see their bat warm up.
Everyone has their role in a baseball lineup and the same is true about an investment portfolio. Some players get on base while others hit for power. Both have an important role within the lineup. Your investment portfolio should have different holdings that spread your portfolio in different categories that complement each other. Stock holdings may be spread across different sectors, regions and currencies. Bond holdings will be spread across different credit ratings and maturities to help you diversify your holdings. These different investments interact with one another to help lower your overall portfolio risk and optimize returns. This is the core principle of diversification.
Having a team full of players who walk a bunch in baseball is fine but without a power hitter who will drive them in they may not be able to translate into runs. Not diversifying your investment lineup can cause similar issues with your financial goals. If you own only your company’s stock, a heavy concentration in one industry, like technology, or don’t invest internationally you’ll be missing out on the benefits of diversification.
A great baseball manager sets their line up and only makes minor tweaks during the season. Your investment allocation should be the same way. It is set up based on your risk number and financial goals you set to reach. It is human nature for us to tinker with things. A manager who messes with their lineup usually does not see improved results. With your asset allocation, your gut instincts to change it up based on the news or your short term opinion of the market will likely add little value and probably hurt your returns. Stick with your diversified portfolio because just like managers you don’t have a crystal ball. The benefits of diversification are seen over long periods and not necessary in the short term.
Investments like a batter over a season will experience ups and downs. A great manager keeps sending their best players out to bat even when they are in a slump. They never know exactly when they will break out but they are confident at some point they will return to their historical average. In your diversified portfolio, you never own enough of the winners and feel like you hold more of the losers than you would like. This is the nature of diversification.
Ben Carlson from A Wealth of Common Sense says this about diversification; “Diversification is about accepting good enough while missing out on great but avoiding terrible.” Good enough from a lineup of hitters will lead a team to the post season. The same holds true for your investments. A diversified investment portfolio does not have to have exceptional returns for your financial goals to be met. Sticking to your plan will allow both your favorite team (hopefully the Royals) and you to meet your goals.
Andrew Comstock, CFA
Disclaimer: The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.