Written by Lee Stoerzinger, CFP®
If you were to ask someone about the rules of investing, it probably wouldn’t be long before you hear the word ‘diversify’ as a key pillar. We have all been told this so we don’t have all our eggs in one basket, as they say. Investing and diversification is something that, on its face, seems very straight forward. In reality, it can be extremely complex. The art of building portfolios is challenging for sure, but let’s cover something which may be an equally difficult task—the emotional side of staying diversified.
So, if we agree that diversification is a time tested tool for long-term investment success, how do we so easily end up making decisions which go against it, such as holding 100% of retirement funds in employer stock, despite the risk? Why do we follow certain short-term trends that our friend tells us about? Or how are so many of us continuously searching for things that are doing ‘better’ with little regard for our specific plans? One word—emotions. We get it. After all, why wouldn’t someone just look to markets that are poised to go up and invest in them? Or, if an investor has 10 holdings and some are doing better than others, why wouldn’t you get rid of the ones that are not doing as well? This is where the complexities come in because there’s more to the story.
As humans, especially with the amount of information available to us today, the emotional side of investing can follow hand in hand with the technical as we look at our portfolios and measure results toward our goals. I freely admit it is easy to get caught up in the noise and perceived opportunities for short-term gains. However, after almost thirty years in business, we have found that certain rules, when followed, tend to provide benefits that shortcuts do not.
A few questions to help muddy the waters and prove some points. If we see an investment that we discern is doing better, we have to ask—doing better than what? Over what time period? Does it have the same fit and take the amount of risk we agreed on? If we look to sell things that are not doing as well as others in our portfolio, do we understand why we own them in the first place? What role do they play? Will we ever buy them again; and when? Are we looking for performance compared to our needs, or just the markets in general? If we get significant downturns, do we understand how veering from the plan might look? And on and on.
Let’s cut to the chase. We strategically diversify our investments for very specific reasons. First, we seek to protect against concentrated downside risk. Second, we do it not for the things we can predict, but for those we cannot. And finally, investing is about averages. There will always be one thing doing better than something else. That’s how it works. If we understand this, then we know that anything we do in the short term just may derail our longer-term plans. The very thought of taking an investment with five different parts, looking at it, and then wondering why you can’t just have all of it in the one which is doing the best feels so natural. But the truth is, this kind of thinking defies the rules, causes us to make bad decisions, and possibly not meet our goals.
When we find ourselves getting lured into these situations, the best thing to do is step back, think about our actual plans, and how much of the decision is emotional. No matter how ‘right’ it feels in the moment, it may just be presenting you with a perfect example of why investing can be so challenging.
This content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security. Diversification is an investment strategy that can help manage risk within a portfolio, but it does not guarantee profits or protect against loss in declining markets.