You have probably been in an all-purpose motor vehicle at some point in your life and appreciated the experience most when you left smooth city roads for country dirt tracks. In the investment world, highly diversified portfolios can provide similar reassurance.
With blue skies and open motorways (that would be nice!), small city cars might cruise along just as well as sturdier 4x4s or a sports utility vehicle (SUV). But the real test of your car occurs when the road and weather conditions deteriorate and you need to focus sharply on what you are doing. Have you ever stopped and wondered just how deep the water is that is blocking the road ahead? Will you get through without the engine stalling?
That’s why people who travel through different terrains often invest in a SUV that can accommodate a range of environments, but without sacrificing too much in fuel economy, efficiency and performance.
Structuring an appropriate portfolio for you involves similar decisions. You need an allocation that can withstand a range of investment climates while being mindful of fees and taxes.
When certain sectors or stocks are performing strongly, it can be tempting to chase returns in one area. But if the underlying conditions deteriorate, you can end up like a motorist with a flat tyre on a deserted B-road in the rain and without a spare. Not nice.
In recent years as China’s seemingly limitless growth fuelled a ‘bubble’ in the commodities market a company called Glencore was the ‘darling’ of the stock market analysts. Similarly, as Volkswagen finally overtook Toyota to become the worlds’ largest car manufacturer, many investors bought heavily into their story and their stocks.
An alternative to such focused stock picking is to build a broadly diversified portfolio. That means spreading risk in a way that helps ensure your portfolio captures what global markets have to offer, whilst reducing unnecessary risks. In any one period, some parts of the portfolio will do well. Others will do less well. You can’t predict which. But that is the point of diversification.
Now, it is important to remember that you can never completely remove risk from any investment – and that includes cash in the bank. Even a well-diversified portfolio is not puncture-proof. We saw that in 2008-09 when there were broad losses in all markets. It becomes even more specific when you consider what has happened recently to the stock of these two major corporations; Glencore and VW.
You will notice from the bars above that the trading of their shares was peaking as the the price collapsed. Not very wise.
Concentrated bets might pay off for a little while, but it is hard to build a consistent strategy out of them. And those fads aren’t free. It’s hard, if not impossible to get your timing right and it can be costly if you’re buying and selling in a hurry.
By contrast, owning a diversified portfolio like the ones we build at Capital, is like having an all-weather, all-roads, and fuel-efficient vehicle in your garage. This way you’re smoothing out some of the bumps in the road and taking out the guesswork.
Add discipline and efficient implementation to the mix and you get a structured solution that is both low-cost and tax-efficient.
Just as expert engineers can design fuel-efficient vehicles for all conditions, the astute financial planners at Capital know how to construct globally diversified portfolios to help you capture what the markets offer in an efficient way while reducing the influence of random forces.
There will be rough roads ahead, for sure. But with the right investment vehicle, the ride will be a more comfortable and enjoyable one for you to take.