Who’s your World Series pick in pro baseball? Whichever team you favor, how the best squads get together can teach you a thing or two about your own investing. Here’s what to know.
For instance, diversification of your assets can be an easy concept to explain and difficult for you to embrace. Maybe you heard about it in terms of all your holdings depending on the solidity of one basket. This is far too simple a metaphor.
It’s better to spell out the idea like a baseball batting order. A baseball manager has nine players who get to bat. There are many moving pieces in a baseball lineup and each interacts to give a team the best possible outcome over a long season.
At any given time, some players will be hot while others slump. You can say the same about investments in a diversified portfolio.
We’ll use an example of a portfolio of 80% U.S. Stocks and 20% international stocks. In some years, both markets rise in tandem; over shorter periods maybe one does better than the other. You can’t predict with great accuracy when one market will outperform just like you can’t foresee when an individual hitter will see the bat heat up.
Some players swing for the fence; others just hit to get on first base. Both play an important role within the lineup. Your investment portfolio needs different holdings that spread your portfolio across separate, complementary categories. Your stock holdings may span a multitude of sectors (types of industries), regions and currencies. Your bond holdings can spread across different credit ratings and maturities.
These different investments interact with one another to help lower your overall portfolio risk and optimize your returns – core principles of both teamwork and diversification.
A team players who get to base only after walking on four bad pitches is fine, but without a power hitter to drive runners home, runs might be in short supply. Not diversifying your investment lineup can cause similar issues with your financial goals. If you own only your company’s stock, for instance, a heavy concentration in one industry such as technology or one nation such as the U.S. can mean you miss real benefits of diversification.
A great baseball manager sets a lineup and only makes minor tweaks during the season. Your investment allocation needs to follow the same plan, based on your risk number and long-term financial goals.
Yes, we all love to tinker. A ball manager who constantly messes with the lineup usually just hurts the team, though. With your asset allocation, your emotional instincts to change, based on the news or your short-term opinion of the market, are similarly likely to add little value and probably hurt your returns.
Finally, a great manager keeps sending the best players out to bat even when they are in a slump. In your diversified portfolio you never seem to own enough of the winners and feel like you hold more of the losers. This illusion is one aspect of diversification.
Writer and chartered financial analyst Ben Carlson says, “Diversification is about accepting good enough while missing out on great but avoiding terrible.” Your portfolio doesn’t need exceptional returns for you to meet your financial goals. Careful planning and patience usually produce winning records on both the ball diamond and Wall Street.
Follow AdviceIQ on Twitter at @adviceiq.
Andrew Comstock, CFA, is president and chief investment officer of Castlebar Asset Management in Leawood, Kan.
AdviceIQ delivers quality personal finance articles by both financial advisors and AdviceIQ editors. It ranks advisors in your area by specialty, including small businesses, doctors and clients of modest means, for example. Those with the biggest number of clients in a given specialty rank the highest. AdviceIQ also vets ranked advisors so only those with pristine regulatory histories can participate. AdviceIQ was launched Jan. 9, 2012, by veteran Wall Street executives, editors and technologists. Right now, investors may see many advisor rankings, although in some areas only a few are ranked. Check back often as thousands of advisors are undergoing AdviceIQ screening. New advisors appear in rankings daily.