Now for the third part in our Look At It This Way series, in which we explain complicated financial concepts by way of a visual metaphor. This time we take a look at investing’s “all-roads vehicle”.
Have you ever tried to take your around-town car on a cross-country trek? The compact little sedan that is such a convenience in the city suddenly becomes inadequate on rough rural roads. Likewise, that four-wheel drive monster that feels indestructible in the open country turns into a liability in town – too big for the narrow streets, too fuel hungry and impossible to park.
What you need is an all-roads vehicle – sufficiently sturdy and rugged for off-road tours, but still sleek, economical and agile enough for urban streets.
Having a car for all climes is like having an investment portfolio for all market conditions. With shares alone, the ride may be exciting, but you’ll also feel every bump along the way. Adding fixed interest is like building up the suspension.
Look at it this way: Diversifying your sources of returns gives you more flexibility and means you don’t have to keep chopping and changing as you go – like someone swapping out of the Range Rover into the Mazda as they drive back into the city.
In contrast, a concentrated portfolio is like taking a car made for city driving into rough country roads. While there’s a temptation when the roads are smooth and clear to put your foot down, being overly reckless can leave you in inhospitable areas that are hard to negotiate out of.
Of course, there’s always a possibility your small city vehicle will come out of the country trip unscathed, if a little dirty. But the fact is you’re taking a gamble you don’t really need to take. Better to have a vehicle, which while compromising on some speed and agility, makes up for it through sturdiness and resilience.
As with motoring choices, getting the balance right in investment is the nature of great asset allocation. And this in turn is a function of your age, circumstances, habits and goals. Everyone’s vehicle will be different. Features will vary. But that is because people are different.
The globally diversified portfolio – like the all-roads vehicle – is a good starting point.
If you enjoyed this article, why not catch up on the previous entries in this series?