Your Wealth Journey Investment Insights – Diversifying for a Smoother Ride

Have you ever ridden in a car with bad suspension? You know the feeling, where every bump feels like a meteor strike right next to the wheel. It’s not fun. You get bounced around, maybe hit your head and forget what just happened. When you wake up, your brokerage account is half empty and there’s a man waving smelling salts under your nose.

Maybe we’ve gotten ahead of ourselves here, but you get the picture.

Now, imagine riding in a luxury sedan with four-wheel independent suspension. It’s like riding on a pillow in a cloud with a leather-wrapped steering wheel. But why does it feel so much better? What is at play?

The key is distribution of stress.

When the car hits a bump, the shock absorber...well, absorbs the force, keeping the car’s interior nice and smooth. And, when one wheel hits a pothole, the others hardly notice.

You could say that the car’s suspension is diversified across its four wheels, protecting the other three from the jostle absorbed by one.

This is exactly how diversifying for a smooth investment ride works. Let’s dig in.

DIVERSIFYING FOR A SMOOTHER RIDE

In the near term, market returns can look like a jagged mountain. While you might be able to climb high on the back of a sharp run, you can just as easily fall off the cliff on the other side.

When you crunch the numbers, diversification is shown to help minimize the leaps and dives you must endure along the way to your expected returns.

Imagine several rough-and-tumble, upwardly mobile lines that represent several kinds of holdings. Individually, each represents a bumpy ride. Bundled together, the upward mobility by and large remains, but the jaggedness along the way can be dampened (albeit never completely eliminated).

If you’d like to see a data-driven illustration of how this works, check out this post by CBS MoneyWatch columnist Larry Swedroe, “How to diversify your investments.”

Diversification cannot reduce the volatility of the overall market, but it is still important because it reduces the risk associated with individual firms or asset classes.

COVERING THE MARKET

A key reason diversification works is related to how different market components respond to price-changing events. When one type of investment may zig due to particular news, another may zag.

In the case of the car, as with diversification, you don’t need to swerve for minor bumps if your suspension is good.

Instead of trying to move in and out of favored components, the goal is to remain diversified across a wide variety of them. This increases the odds that, when some of your holdings are underperforming, others will outperform or at least hold their own.

The results of diversification aren’t perfectly predictable. But positioning yourself with a blanket of coverage for capturing market returns where and when they occur goes a long way toward replacing guesswork with a coherent strategy.

GOING WITH THE FLOW

The great thing about diversification is that it allows you, mostly, to relax and go where the market takes you. If you’re well diversified, the chances are higher that you’ll see smooth returns over the long term.

DISCLOSURE: Securities offered through WFG Investments. Member of FINRA and SIPC. Investment advisory services offered through WFG Advisors, LP. Diversification: Diversification does not assure or guarantee better performance and cannot eliminate the risk of investment losses.

Read More from Atlas Wealth Advisors

• The Introduction to this Series: Becoming a Better Investor
• Start Your Retirement Journey Series
• Find Your Financial Focus

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