Diversification our Take
Let’s use today’s post to focus on the rationale for diversification shall we. We have been asked by a few of our associates for a simple explanation one that can transcend all walks of life, so here we go.
Diversification - the offsetting of risk by offering and executing within multiple constructs to achieve the most optimal outcome given a certain amount of risk tolerance.
This is not singular to investing or trading, but to all facets of one’s life. Example you want to buy a home, but you have limited resources, what do you do? You have to find the best available option working within whatever parameters and constraints limit your decision.
So in Real Estate, we all know the old adage, “Location is Everything” right? Well we want good schools, safe neighborhoods and hopefully neighbors that don’t annoy us! Yea I know a lot to ask for, but here’s the thing even in the home hunt we diversify, we can choose generally an acceptable, affordable choice but have to sacrifice distance from work perhaps, we have to sacrifice home size, redone move in ready vs fixer upper.
Ok you guys right now are like what does this have to do with diversification??? Well everything actually. When we look at our initial problem we stated its about “obtaining the most optimal outcome given a certain amount of risk.” When we sacrifice one option for another these choices are actually diversifying our “CHANCES” of achieving OUR RESPECTIVE OPTIMAL OUTCOME!
Alright now to brass tacks, we aren’t going to give you the academic definitions of risk usually done with a slew of Alpha, Beta, Standard Deviation, etc, who cares! Yes sorry academics, in the real world its not that easy, but don’t get us wrong, we use those everyday, yet for this domain, lets keep it very simple.
The old back of the envelope calculation for an investor in regards to equity percentage exposure was to take your age and subtract it from 100.
Example: Investor A is 70 years old, thus his net exposure in his total portfolio should be 100 - 70 = 30. So the investor should be in 30% equities and his other holdins should be DIVERSIFIED into various other assets such as Fixed Income (Bonds), Alternatives, Real Estate, Cash Etc. Obviously the biggest nut should be the equities the majority of one investors life, yet as they near retirement, the key no longer becomes capital appreciation, but Protection and TIME!
We write about time all the time! In fact we often talk that its the Federal Reserve that is the best at buying it, all of their QE programs, they aren’t asset price expanders, well they are, but in reality they are time buyer, decades of it in fact. That is how we look at it. So back to the story. The investor now today has been lulled into central bank debt bonanza sleep for quite some time and today isn’t the old 100 - age calc. Rather we feel that the new number is roughly around 115/120 or so and this is purely because people are working longer and living longer productive lives.
So to answer an appropriate Equity exposure for a given investor lets just say there are many variables, kind of like fractal geometry, you can look at it from a far or take a microscope and the picture is just a reoccurring loop of its original self. Think about risk this way, it never changes, its always there, its us that changes and you better recognize your tolerances not of risk, but of you own longevity and TIME!
As a side note, even with the 115 -age a 70 year old would be in 45% equities and if they are a bit more tolerant of time and risk well they can maybe bump it to 50%. However the appropriate thing to do is to move into fixed income and always keep some percentage in alternatives as your diversification not for alpha, but to protect against both inflation and offer the ability to offset any down years to our equities (if there ever is such a thing!)
Alright hope that helps, till next time!
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-Magnelibra Econemotions
DISCLAIMER: For educational purposes only. This is not a solicitation to buy or sell commodity futures or options on neither commodity futures. The risk of trading securities, futures and options can be substantial and is not for everyone. Such investments may not be appropriate for the recipient. The valuation of futures and options may fluctuate, and, as a result, clients may lose more than their original investment. Nothing contained in this message may be construed as an express or an implied promise, guarantee or implication by, of, or from the author Michael Agne owner of Magnelibra Capital Advisors. We will never claim that you will profit or that losses can or will be limited in any manner whatsoever. Past performance is not necessarily indicative of future results. Although care has been taken to assure the accuracy, completeness and reliability of the information contained herein, we make no warranty, express or implied, or assume any legal liability or responsibility for the accuracy, completeness, reliability or usefulness of any information, product, service or process disclosed. ALL RIGHTS RESERVED 2021