Commandment 5: Diversify Thoughtfully
This is the fifth of a ten part series where we look at Haven’s Ten Commandments, a short list of investing fundamentals we like to teach to our clients. It’s nothing too fancy, but a good foundation we believe everyone should understand.
Before the 2018-2019 NHL season the Winnipeg Jets had the second best odds to win the Stanley Cup at 10-1, behind Tampa Bay. St Louis started the season with 40-1 odds, and were even 250-1 odds in January when they sat near the bottom of the league. I’m sure there’s a lot of analytics that goes into these odds, who’s on the team, how they compare to their closest rivals, etc. For fans they would most likely pick their favourite team simply out of loyalty.
So let me ask you, who do you think will win the Stanley Cup in 2020? If you had to pick one team, you’d have a 1/31 (3.2%) chance of being right, odds aren’t really in your favour. But if I ask you what 10 teams you think have the best chance to win it all, you’re looking at much better odds (32.3%). St Louis went on to beat Winnipeg in the first round, and surprise other teams along the way to winning their first Stanley Cup.
Investing doesn’t have to be too complicated or fancy, but there are tools we can use to help ourselves out. I think most people are familiar with the phrase, “Don’t put all of your eggs in one basket”, or “safety in numbers”. With investing this refers to the concept of Diversification.
Diversification is the act of investing in a variety of different assets, with the aim of reducing risk. This way if one company performs poorly (earnings are less than expected), or a sector slows down (oil prices drop) it has little effect on your overall portfolio performance. By taking several educated risks, we are investing more thoughtfully and efficiently than had we only taken one.
Investing in either too few, or overly risky assets (small cap or penny stocks) you expose yourself to the real risk of permanent loss. But investing in a diversified approach within many different companies and sectors will reduce risk without sacrificing return. By diversifying our portfolio (instead of picking one team to win the Stanley Cup) we place a bet saying any of the top teams will win - which almost seems like cheating, but it’s not.
In 2008 when the subprime housing crisis hit the US, people panicked and converted their investments to cash. Across the board stock markets declined more than 30-40% over a short period of time. But the culprit was the market, not the underlying businesses. It didn’t necessarily mean that those companies the market represents were 40% worse off than they were prior to the crash. Since that crash, the markets have been in one of the most, if not the most, powerful periods of growth we’ve ever seen — where even with the loss in 2008, people have been able to make back what they lost and then sometimes multiples of it. When markets crash, it’s like stocks going on sale.
The main point being, if you’re investing smartly to manage risk by diversifying, then overall market trends don’t need to be of concern. You can rest assured that over the long term you’re going to experience more growth than decline, and down markets merely become an opportunity to buy great businesses on sale. Then you can enjoy the ride back to the top. By consistently betting that any of the top 10 NHL teams will win the cup in any given year, you’re going to be right far far more than if you only pick one — and you won’t get caught betting the farm on the league favourite, (Tampa) before they get swept in in the first round.
Haven works with some of Canada’s most talented portfolio managers that excel in following or outperform markets. They do this by being well diversified, charging low fees, and being very good at what they do. Haven takes a lot of pride in being able to offer people investment solutions that match their needs perfectly, investing smartly and diversified is embedded into each solution we have available.
If you have any questions about diversification and risk, investing in general or learning about how Haven can help you, please don’t hesitate to contact us.