Chances are, you have heard some form of this saying before: “You are what you eat.” I happen to like the original quote from Jean Anthelme Brillat-Savarinin (a famous epicure) written in 1826, which translates to: “Tell me what you eat, and I will tell you what you are.” Sometimes the simplest of sayings can be the most practical and truest for our own everyday living. Food is vital for our survival, and the diets we choose play a significant role in our health. In looking at the typical food pyramid, we can make some key inferences on how we are to go about maintaining a healthy and balanced diet. It turns out that food and the various food groups we consume have a lot of similarities to investing and the assets we choose. Further, our need for a balanced diet is akin to the need of a diversified portfolio.
For the sake of this conversation I will be primarily referring to asset classes as paper investments (think stocks and bonds), but I recognize the use and importance of physical assets such as land, properties and business capital.
Proteins and Equities
Protein is an important building block for our muscle and bones and helps repair tissue. Meats (with limited intake), eggs, nuts, yogurt, and cheese are all good sources of protein. Protein consumption is important in all stages of our lives; however, it’s crucial during our childhood and adolescent years.
In the financial space, equities are also an essential building block. Equities vary greatly but generally provide ownership of companies through the purchase of shares. They can be large or small, growth or value oriented, based in the U.S. or worldwide. There are over twenty subcategories of equities and they are the building blocks of the world economy. In a given portfolio, they are used to provide potentially higher growth and appreciation than other asset classes. Aside from growth, equities also can provide a buffer against inflation and purchasing power over the long term. Equity investments tend to be less stable and more volatile than other asset classes — hence the tradeoff of risk vs. reward. When viewed in a long-term investment horizon, they are essential for any investor regardless of age.
So, just as not all sources of protein are ideal for a healthy diet, not all equities are deemed quality. One must look at the “ingredients” to determine the “nutritional value”, and one must also look into the key fundamentals of companies to determine whether the investment is sustainable or not.
Carbs and Fixed Income
Whole grain rice, pasta, oats, legumes, peas and parsnips are all great sources of carbohydrates. Carbs provide us with energy, mental health, weight management and a healthy cardiovascular system. They energize those muscles we developed from the protein we referred to earlier. In fact, a healthy recommended diet consists of over 50% carbohydrates.
Fixed income investments also have varying levels of offerings, and like carbohydrates in a healthy diet, they support an active and healthy investment portfolio. They generally refer to bonds — investor loans to borrowers for a return of scheduled interest payments and principal investment at a future date. Rationale for fixed income in a diversified portfolio would be the general nature of lower levels of market volatility vs. that of equity investments. Also, fixed income investments usually have higher returns than do cash, while also providing some form of steady income payout.
Sugar and High Risk Investments
Healthy diets are best supported by limiting the intake of high sugar food products, such as soda, ice cream, and candy. While they may appear tempting and highly rewarding, they can also do lots of damage if not controlled.
Similarly, a healthy and properly diverse investment portfolio would be best positioned to limit exposure to high risk debt instruments such as junk bonds, as well as paying particular attention to other forms of risks as it pertains to the bond market.
Water and Cash
Water makes up most of our bodies.. Our thirst for water is greater than for any other substance. Water helps deliver nutrients to various regions of the body, it helps remove waste, it helps to regulate our body temperature and it balances the blood in our body.
Just as water is so vital in our bodies, cash is king for daily living and for facilitating business. Cash is also the most liquid investment of all asset classes (pun perhaps intended). Cash can include money market funds, savings accounts, and — in some instances — ultra-short-term bond funds. Couple the ease of access with low price risk and low volatility, and it becomes a central point I emphasize with my clients. Having cash reserves allows investors to stay invested during periods when they need to cover life circumstances and other obligations. Relative to cash, investors should also be aware of the erosion of the dollar, which can be amplified during times of high inflation.
Fats and Alternatives
Though daily intake of fats and oils comprises a mere five percent of a balanced diet, it still plays an important role. Dietary fats provide our bodies with energy, preserves our organs, supports cell growth, keeps blood pressure and cholesterol under control, and helps our bodies absorb nutrients. Avocados and oils from peanuts, coconuts and olives are all good sources of fat.
For your “financial diet,” you could consider alternative investments to fill this requirement. This includes investments such as Real Estate Investments Trusts (REIT’s), commodities, gold, hedge funds and several other subcategories. In a diversified portfolio, alternative investments can provide low to negative correlations to typical equity and fixed income investments. They can also serve to hedge from inflation. Potential concerns with this asset class could be high costs, high levels of volatility, deflation risk and “feast or famine” returns.
Balance and Diversification
The true victor here is the value found in the sum of the parts. Diversification reduces exposure to a single asset class by allocating in multiple asset classes. One of my favorite investors, Howard Marks, says it well in his book The Most Important Thing: “A diversified portfolio of investments, each of which is unlikely to produce significant loss, is a good start toward investment success.”
No single asset class is particularly better than the other. They all have value in their own unique characteristics, and should be considered accordingly. This truly brings to mind the concept of a “balanced diet.” It’s also be worth noting that before considering any such balanced financial approach, the self should be examined first. No one person is the same, and everyone is at a slightly different stage in their lives.
Our appetite for diversification should always first be determined by goals-based planning. That is, we should allocate percentages of asset classes as it pertains to the goals we wish to obtain, the risk we feel most comfortable taking, and the time frame in which we believe it will take.
It is my hope that you not only have a plan, but that you are also properly allocated and diversified. Your financial advisor should be eager and able to help build out a suitable investment allocation for you. And if you would like my help, I would be happy to give you my time!
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.