Hi folks. Dave Piatkowski here. I just want to take a few moments of your time to discuss the importance of diversification within your portfolio. For those of you who have read Ron’s book, in chapter 5, he does a great job of discussing that as well.
This discussion will be similar to what chapter 5 talked about. But as far as diversification goes, I would like to bring into play a couple of quick analogies from my background. The first one is one that Ron briefly discussed as well and that’s the pie selection at a church bake sale.
When you talk about a pie sale for a church or any other entity, the ultimate goal of the sale is to maximize the donations or the sales. Initially people tend to just say, “Hey, what’s the most popular? Apple pie? Let’s just do all apple pie.” Well, we’ve found out some things over time – from my being on the finance committee in my church and from Ron’s work in his church. (By the way, I did not bake anything. I was more on the volunteering side.) You need to diversify the pies in order to maximize that income or for the church – or whoever was putting on the bake sale.
If you just did a sale with only pecan pie and apple pie, you missed out on a pretty large number of people. The more varieties of pies that you had, the better the sales were. The rub is, it’s a lot of work on the front end to have all that variety. There’s a lot more work to have that number of pies and so many ingredients, and some people don’t know how to make certain pies and that kind of thing.
But in the long run, the church or whatever the entity makes a lot more money and takes in more donations when you have a diversified number and kinds of pies.
Furthermore, going back to my teaching and coaching background, I’ve coached for the last 20 years. We found that when it comes to basketball defenses, if we play man-to-man all the time or just a certain type of zone all the time – as far as basketball defenses go in middle school, high school, college, what have you – it’s not going to work all the time.
Now some people would say, “Dave, that will work fine if you have the right athletes.” Well, you can overpower another team and that will work fine. But in most cases, you need to change up those defenses in order to get the success that you’re looking for.
Similarly when we talk about your portfolio, some people will come in and will be like, “This particular fund is performing the best. Let’s just put all of our money there.”
That may work fine in short spurts but over time, a well-rounded, diversified portfolio is the success on average that you’re going to get. We want to have all asset classes covered very similarly to having a number of different pies in the bake sale. We want to have small cap, large cap, mid cap, real estate, fixed income, bonds, cash, what have you.
On average, if we do the work ahead of time and get the best class of assets for each category and then rebalance on a regular schedule, the returns on those balanced portfolios with all the asset classes covered are going to give you the best returns over time.