Okay, so my hometown team the Seattle Seahawks is in the Super Bowl, the world’s biggest sporting event outside the World Cup. Now, while I can easily use this space to prove to all of you naysayers why the Seahawks will win the big game, I will spare you. After all, most of you reading this probably couldn’t care less about the game.
Nonetheless, in order for a football team to be successful, they need to rely on some of the same principles that investors use. I’d like to focus on diversification.
A football team isn’t made up of a few star players and a bunch of fill-ins. Each member of the roster plays a very important part in the success or failure of a team. In addition, you need to have a decent offense, defense and special teams to win. If one of those three components isn’t up to par, the chance of success is limited. In other words, you need a diversified team approach to achieve ultimate success.
As is commonplace at the beginning of the year, the financial media is filled with prognostications about what will happen to the financial markets in the upcoming 12 months. I would, however, like to discus a disservice that borders on a contradiction, and it is constantly being propagated by these same “market analysts.”
If one were to start to compile what each prognosticator says, you will find something very interesting. In addition to picking their “hot stocks” for the year, they each provide investors with a proper asset-allocation model. They will say, for example, that for the average investor living in Israel, 40 percent of investable assets should be invested outside Israel, with 10% in the US, 10% in Europe and the rest in emerging markets, including China, Brazil and Russia. They claim that Israeli investors need to diversify their investments, and this is the proper way to do so.
Diversification Firstly, it’s important to define what diversification is.
Diversification is an investment technique that uses many varied investments within a portfolio. The theory states that a portfolio of different kinds of investments will, on average, yield higher returns and pose a lower risk than any one individual investment. Diversification smooths out volatility in a portfolio caused by market, interest-rate, currency and geopolitical risks. In layman’s terms, don’t put all your eggs in one basket.
The first question that needs to be asked is why diversify in the first place? I know people who believe diversification is for wimps. They rightly point out that if Bill Gates had sold off all of his Microsoft stock 25 years ago, he wouldn’t be the Bill Gates we know today. That’s all well and good, but for the overwhelming majority of investors, the money they are investing tends to be their whole life savings, and they can’t afford to take the risk of investing in one asset and hoping to strike it rich. The consequences of a wrong investment decision being made can literally wipe you out financially.
Reduce risk The whole point of diversifying is to lower risk in a portfolio.
My question to all these market pundits is why do they recommend that Israel-based investors move 40% of their money out of Israel and invest most of it in emerging, high-risk markets? And then to say that they are doing this in the name of diversification! To move money out of one high-risk market and put it in another is a classic case of the Talmudic axiom, yatza secharo b’hefseido (his gain is offset by his loss; i.e., you haven’t done anything).
While there is certainly room in investment portfolios for more high-risk emerging-market investments (I wrote a book about that), investors need to be made aware of all the risks associated with this kind of investment. If one lives in Israel, and has much exposure to the small and volatile Israeli market, the point of diversifying your portfolio would be to buy assets that are more stable and lower- risk in your portfolio.
Review If you feel you are too heavily weighted in just a few investments within your portfolio, speak to a financial adviser to review your holdings, and see if you can benefit from proper diversification to help improve returns and lower your risk.
Oh, and GO SEAHAWKS! The information contained in this article reflects the opinion of the author and not necessarily the opinion of Portfolio Resources Group, Inc., or its affiliates.
firstname.lastname@example.org Aaron Katsman is a licensed financial professional in Israel and the United States who helps people with US investment accounts. He is the author of the book Retirement GPS: How to Navigate Your Way to A Secure Financial Future with Global Investing.