Who do you think will win the World Series? Why?
Whatever team you favor, understanding how the best squads get together can teach you a thing or two about investing.
For instance, a manager’s selection of a batting order is a bit like diversifying your investment assets.
A baseball manager has nine players who get to bat. At any given time, some players will be hot, while others slump. You can say the same about investments in a diversified portfolio.
For example, consider a portfolio of 80 percent U.S. stocks and 20 percent 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 the other, just like you can’t foresee when an individual hitter will see his 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 player who gets 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, you’ll miss the real benefits of diversification.
A great baseball manager sets a lineup and makes only minor tweaks during the season. Your investment allocation needs to follow the same plan, based on your tolerance for risk and long-term financial goals.
Yes, we all love to tinker. A ball manager who constantly messes with the lineup usually hurts the team, though. The same goes in investing. Your emotional instincts to change your approach, based on the news or your short-term opinion of the market, are similarly likely to add little value.
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.
Andrew Comstock, is a financial planner and president and chief investment officer of Castlebar Asset Management in Leawood, Kan. He writes for AdviceIQ.