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Do you know what I do when one of my friends rubs me the wrong way? I get together with another one of my buddies.
Do you know what I do when my golf swing starts launching balls further to the right than straight ahead? I pick up my tennis racquet.
Why am I telling you all of this? Because since I’ve been in the financial services industry I’ve noticed a surprising and profound pattern. Diversification is good for your portfolio, and it is also good for you.
Unless you’re luckier than I am, it’s pretty rare for everything to be going well at once. I mean I’ve been very blessed, and compared to many in this world, I have absolutely nothing to complain about, but, even so, there is usually at least one area of my life that could be a little bit better. I think many of you feel the same way. From what I’ve heard from countless friends, family members, and clients, I think it’s pretty common for a spouse to occasionally get under your skin, a friendship to cool off, or a family member to make you seriously consider DNA testing. It’s fairly normal for a boss to act like a “Michael Scott,” a co-worker to make you over-utilize a stress ball, or to occasionally have a bad day at work due to your own actions or lack thereof. There are times when the beach is more fun than the mountains, when you are more excited about learning to play the guitar than your softball league, and when Atlanta Hawks games are more entertaining to you than Atlanta Braves games. None of these occurrences should make or break your life if they are part of your life. What is important is that they are part of your life.
Most investors diversify their portfolios because it reduces the overall risk of their portfolio. Everyday translation: by having your eggs in more than one basket, there’s less of a chance of them all breaking at once. By not being frighteningly obsessed with your job, by having friends outside of your spouse and kids, and by having more hobbies and interests than your weekly poker game with the same foursome, there’s less of a chance that all parts of your life will be going poorly at the same time! If you’re not happy at work, maybe you’re happy at home. If you’re not happy at home, maybe you’re happy at work. If you’re married to your job and are more of a father figure to your subordinates than your own children, and you don’t have a good day at work, what could possibly make you happy at home? If 100% of your friends seem to hang out with you Monday through Friday from about 9:00 – 5:00, who will your friends be when you or they stop working at the same company? If your hobbies are answering work e-mails after work or leaving voicemails at strange hours, what are you going to do when you retire? You know that most companies take your computer and disconnect your phone number when they take your key card, right?
As good as diversification can be for improving an investment portfolio’s risk-adjusted performance, diversification also follows the law of diminishing returns. What I mean is there comes a point after your portfolio is diversified where adding another position or fund in the mix really doesn’t add that much value anymore. To some extent, your investments can become so spread out that you can’t really be in something enough for a gain or loss to significantly move the needle. I think this holds true for life, too. You can be involved in too much. There can come a point where you are spread so thin with your own activities and social obligations that you really can’t take the time to excel in the activity or enjoy the obligation before you have to move on to the next one. Having too many acquaintances can prevent you from having genuine friends. Having too many time-consuming hobbies can hurt your family.
In the investment advisory arena there is a document called an Investment Policy Statement (IPS) that is often drafted between an advisor and a client. In essence, this document provides the general goals and objectives of a client and specifically states ranges of acceptable investment allocation (ex: % allowed in stocks vs. bonds). This allows the advisor to know how much he or she can change the makeup of the portfolio and gives the client the comfort of knowing there are limits to how much the makeup of a portfolio can be changed. Here again, based on my experiences as a normal, everyday person, I think it might be a good idea to apply the IPS mindset to our families, friends, and careers. If you have a busy week ahead at work and you need to rebalance your time to spend more hours at work than usual, that’s fine, but don’t adjust the allocation of work/life balance beyond the amount that is acceptable to your family. If your family is keeping you busy and you need to disappear from your friends for several weeks to do what you have to do, that’s fine, but don’t leave the allocation to your friends below what they expect for too long. If your new stamp collecting hobby has encroached on some of the allocation of your time normally set aside for your wife, that may be fine for a while, but it might not be the best long-term strategic allocation if you know what I mean.
Earlier in this post I said that there was usually at least one area of my life that could be a little better. That’s still true. However, it’s also true that there is usually at least one area or my life that is going pretty well. By diversifying my life, I can focus on what’s going well in the midst of whatever could be a little bit better, and I believe that makes me an overall happier person. On a given day I may not be as happy as an obsessed bird watcher who finally spots some sort of rare finch, but I also won’t ever be quite as sad as a total workaholic whose proposal wasn’t well received. Diversification can help your long term investment returns, but it can also help your return on life!
-Tom
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