As the saying goes, do not place all your eggs in one basket. This is perhaps one of the most important lessons when discussing investment management and retirement planning. Before we dive into the various diversification options, please reference our posts from the previous two months if you need a refresher on diversification in general. (This post will solely cover various positions. In the first month, we discussed stocks and in the second month, we covered bonds.)
We do feel the need to address the concern of over-diversification. Having your investments spread too thin will severely hinder the potential for substantial growth. It is essential to focus on the companies and areas that will outperform and decrease exposure to those expected to underperform. Warren Buffet once said, “Wide diversification is only required when investors do not understand what they are doing.”
Commodities are typically referred to as natural or raw materials. This would include Gold, Oil, Sugar, Lumber, etc. The cost of raw materials is generally linked very closely to the movement of inflation. Therefore, as inflation increases, the price of these positions naturally increases. This increases expenses for many companies and may tighten their margins resulting in less profitability.
These commodities are also influenced by supply and demand. As supply increases and demand decreases, the price will typically go down. If supply decreases and demand increases, prices will generally go up. If there is less production in the economy, oil and gas are not as desirable, so the price will usually decrease. If there is a lot of volatility in equity markets, people will demand gold as a haven so the price may increase.
Currencies are the monetary units various countries use. For example, in the United States, we use the US Dollar. The Euro, British Pound, Japanese Yen, and Mexican Peso are other examples. Often currencies are shown about one another. (Euro/USD, GBP/USD, etc.) This is because currencies are typically exchanged for one another. As a result, the best way to show the pricing is the relative strength between each other.
As the USD goes up, other currencies will typically devalue against it. When the USD falls, other currencies normally increase in value. Everything from GDP to interest rates and supply/demand for the currency can affect the pricing. Also, fiscal and monetary policy can influence currency prices since the underlying government is affecting the money supply.
Similarly to currencies, it is possible to diversify investments across various countries. For example, stocks and bonds both exist outside the United States, and investing globally allows an investor to spread out their risk if the US economy is slowing, but the rest of the world is growing.
Typically, international investments are categorized into either a Developed Market or an Emerging Market. A developed market is a fully advanced nation and includes a large amount of business and economic productivity. Emerging markets are typically much smaller nations that still have more growth potential and include more risk.
An inverse position moves opposite of the underlying investment. An investor may want to buy one of these positions if they expect the underlying asset to decrease. If that were to happen, the inverse would increase in value. Inverse funds include bonds, equities, currencies, and commodities.
If you have any questions about taxes, your investment portfolio, our 401(k) recommendation service, or anything else, please call our office at (586) 226-2100. Please feel free to forward this commentary to a friend, family member, or co-worker. If you have had any changes to your income, job, family, health insurance, risk tolerance, or overall financial situation, please give us a call to discuss it.
We hope you learned something today. If you have any feedback or suggestions, we would love to hear them!
Zachary A. Bachner, CFP®
Robert L. Wink
Kenneth R. Wink
James D. Wink
Summit Financial Consulting