Profitable investing starts with a plan. It starts with investors reviewing their goals, their fears, how much time they have, how much access to their money they need, and other circumstances. No one plans to fail, but many people fail to plan. And if you don’t know where you’re going, any road will do.
But once you have a plan, what do you do? Investing is a prospective activity. The results depend on things that we don’t know. What will the economy do? What will the Fed do? How will company managers respond? What conditions will change—politically, technologically, socially, geopolitically? We don’t know the future. The best we can do is make educated estimates.
The rational response to in the face of such uncertainty is to spread the investments around: different asset classes, different industries, different capital structures, different places in the economy. At a minimum, a portfolio should have securities that do well if the economy accelerates, if it keeps going the way has it has, and if it slows—or contracts. There should always be some assets that do well under widely various scenarios.
In this way, diversification reduces risk. If different parts of the portfolio go in different directions, they cancel each other out and reduce the overall volatility of the entire portfolio. It’s not a free lunch, but diversification is a cheap snack.
Planning comes first. But the second tip? Diversify.
Douglas R. Tengdin, CFA
Chief Investment Officer