Like most people here in the South, I enjoy college sports. There’s something special about watching great teamwork at play that I find both entertaining, and inspiring. It’s something you can appreciate even if you’re not familiar with the sport; there’s fluidity and assuredness in the way the players complement each other as they work toward a common goal of winning the game.
If you are putting together a five person basketball team, you might look for common characteristics, such as speed, strength and height. Of course, you don’t expect – or even want – every member of a team to have the same gifts, fulfil the same role or perform each task at the same level. There must be a balance between the common characteristics you seek and the diversity of gifts required to succeed.
Know Your Strengths
You might have a terrific inside player who is seven feet tall and strong as an ox, whereas you would want a smaller, quicker player manning one of the outside guard positions. You expect more rebounds from your inside player and you expect more three-point shots from your outside player. Those are their roles. You know that the different players bring different strengths to the team and fulfil different roles, and that is okay, even preferred.
Similarly, in a well-constructed team of investments (often referred to as a portfolio) consists of different asset classes (or funds) that play very different roles, but they work together toward a common purpose of helping you achieve your goals.
Consider Your Play
Although there are common things that you should consider when evaluating investments, such as looking for funds with low expense ratios, stable management and minimal asset drift, you don’t expect – or even want – each fund in your portfolio to have the same characteristics, achieve the same annual return or react to economic forces in the same way.
Different funds provide different protection and opportunity. For example, one fund may typically provide portfolio protection in an inflationary environment, whereas another fund may typically provide more opportunity when inflation is low. Rather than choosing one fund over the other, investors should consider including both funds in a portfolio because accurately and consistently predicting which part of the market will perform the best over a given period is very difficult, if not impossible.
Use Your Team
Even if your economic and market predictions at first appear correct, market momentum, much like momentum in a basketball game, can swing quickly and decisively. For example, when the Russell 2000 Index was down -13.97% year-to-date on February 10, 2016, few would have predicted that it would finish 2016 up 22.42% for the year! The fixed income in a portfolio would soften the blow of the beginning-of-the-year decline in the Russell 2000 and a fund that contains US small cap or micro cap stocks would ensure that you also participate in the asset class’ year-end rebound.
Instead of placing your hopes in the success of one type of asset class or getting frustrated when one asset class doesn’t perform as well as some of the others, the smart thing to do is construct a team of investments that are diversified among different companies, types of securities, sectors and countries in a mix that is consistent with your risk tolerance, which will increase the likelihood of reaching goals.
It is important to realize that just as no college basketball team has won every game in the past forty-two seasons, no one asset allocation will outperform during every period. An investor shouldn’t expect diversification to always produce the highest return. After all, a diversified portfolio is designed in such a way as to ensure that it will not perform as well as the top-performing asset class, nor will it perform as poorly as the worst-performing asset class.
A diversified portfolio can’t completely eliminate volatility; however, by putting together a well-rounded team of investments within your portfolio, you can reduce your reliance on any one asset class and smooth out performance extremes.
If you would like to discuss your investment portfolio in more detail then please get in touch and we’ll be happy to help.