Often when I speak with clients, I rely on a few analogies to break down various investing concepts. For one of the most important principles for every investor — diversification — I like to draw comparisons with baseball. You probably already guessed that I’m a huge baseball fan, so using it in examples lets me combine two passions: one of my favorite sports and helping clients feel confident about their investments.
Each Position Plays a Specific Role
Let’s start with a short definition. Diversification simply means spreading out your investments over multiple asset classes that respond differently to market changes. Types of asset classes at a high level include stocks, bonds and cash positions.
Like the players on the field, each of those asset classes has its own characteristics and unique abilities. Whether it’s the catcher, pitcher or center fielder, each position has a job to fulfill in order to meet a specific goal and objective on the team. Everyone’s role is important; it’s the same with different asset classes and the makeup of your investment portfolio.
Are All Your Positions Covered?
In baseball, nobody knows which part of the field the ball will be hit. In a normal game, you’d position your players across the field to improve your chances of catching the ball. However, what if you positioned all your fielders at first base, leaving the rest of the field open? It may sound foolish, but that’s what many investors unwittingly do with their investments. When your portfolio is made up of similar investments, it’s like having an entire team of first basemen. You know what would happen if there’s a line drive to left field hit—there’s no coverage.
Additionally, many investors wait to watch where the ball is hit and then shift all their players to try to cover that position. The result is part of the field is still left open and uncovered, exposing the team to increased risk. You’re left with a team of players who all tend to bat, defend and perform at a similar level. We see this when one type of security is doing well; investors chase after returns in one sector, or give up on others, because they may not be currently performing well.
Different Players Can Help with Market Defense
Is your portfolio ready for whatever situation the market may bring? Is it ready for a ball to be hit to any part of the field? Markets are unpredictable. The purpose of combining different asset classes is to be ready for various market conditions to help provide more consistent, less volatile returns over time.
Diversification should go beyond the general categories of stocks, bonds and cash. Each of these can be split further into more specialized categories to take advantage of different parts of the market. For example, in the stock portion of your portfolio, you can choose funds that invest in companies of various sizes or locations (example: U.S. or non-U.S.). You can also choose funds that select companies based on a particular investing style, such as growth or value.
Cover the Field with Fund-of-Funds
Diversifying your investments may seem complicated if you try to research and select each type of asset on your own. Most mutual funds allow you to spread your money across securities in a specific category. You can go beyond that with a fund-of-funds investment, which provides a mix of funds that cover multiple asset categories in a single product. More important, just like a good baseball coach, when you choose an experienced fund manager, they will carefully select the investments in these portfolios so that they work can together as a team, giving you better chances for a winning result.
Call on Our Team to Help
We can help you cover your portfolio bases and find the type of fund-of-funds that’s right for you.
Diversification does not assure a profit nor does it protect against loss of principal.
The performance of the target funds is dependent on the performance of their underlying funds, and will assume the risks associated with these funds. The risks will vary according to each portfolio’s asset allocation, and the risk level assigned to each portfolio is intended to reflect the relative short-term price volatility among the funds in each.