Everyone wants a tip. What’s the best way to make money?
Photo: Nick Stanley. Source: Life of Pix
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 assets 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 even contracts. There should always some assets that perform well under widely different scenarios.
In this way, diversification reduces risk. If different parts of the portfolio go in different directions, they cancel each other out and the volatility of the entire portfolio is reduced. 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