Diversification and Asset Allocation – What to Consider

Diversification and Asset Allocation – Knowing One Big Thing or Many Things?

Are you familiar with the hedgehog and the fox? The frequently cited parable by Greek poet Archilochus goes like this: “The fox knows many things, but the hedgehog knows one big thing.”

This quote, and the subsequent story by Isaiah Berlin, were used in Nate Silver’s The Signal and the Noise to explain FiveThirtyEight’s approach to forecasting – using a pluralistic view instead of sticking to one big idea to forecast more accurately.

The NPR podcast, Hidden Brain, interprets the story as contrasting two cognitive types – big-picture people (hedgehogs) and those comfortable with contradictions and nuance (foxes).

When you’re running a company, you generally have one big organizing idea that guides the decisions you make. However, if this doesn’t change over time when faced with changes in the market or society, you can find that you fall behind, or worse, become obsolete. The recent BlackBerry movie shows us the dramatized version of the true story behind a company that couldn’t innovate quickly enough to go toe-to-toe with the iPhone.

Even when you’re thinking about one big idea, it’s important to account for nuances. In investing, this is where diversification and asset allocation come in. We’ll talk about diversification, asset allocation, and how you can use these strategies to improve your investment portfolio. Plus, we’ll discuss how Investream is thinking like a fox – adapting to new information and embracing change with our investment strategy.

What are asset classes?

Check out our webinar all about asset allocation and diversification.

Asset classes are types of assets that are grouped together based on their similarities in risks and returns. They tend to be governed by the same rules and regulations and are often traded in the same financial markets. Asset classes are also often evaluated and discussed as a group in terms of their average return, level of risk, and other distinguishing characteristics.

What are the three main asset classes?

The most common asset classes people are likely to invest in are stocks (equities), bonds (fixed income), and cash (or cash equivalents). When you invest in equities, you are taking ownership of a portion of the company. Bonds are loans that are provided to a company or government, where interest is paid over time. Cash is generally associated with shorter-term investments, like Treasury bills, or money that is placed in a savings or checking account.

Typically, cash and bonds are less risky than stocks, but they also yield lower returns. Someone who is interested in reducing their risk may have a lower percentage of equities in their investment portfolio.

What is asset allocation?

With asset allocation, investors divide their portfolio between various asset classes. The end goal is to find an asset mix that can help investors reach their desired return at a level of risk that is tolerable to them.

While a typical asset allocation may look at the distribution between stocks, bonds, and cash, a more expansive asset allocation can also include alternative investments.

What are some alternative asset classes?

A way to spread asset allocation further is by investing in alternative asset classes. These can include real estate, commodities (raw materials like gold or oil), hedge funds, private equity, art, and more.

Alternative asset classes can be invested in either directly or indirectly by way of a fund or trust. Funds can allow people to invest in smaller portions of an alternative asset class, or can allow for greater diversification across an asset class.

What is diversification?

Diversification takes things one step further. Instead of simply spreading allocations across asset classes, diversification also considers how investments are spread across industries and companies.

For example, one of the reasons Silicon Valley Bank collapsed was due to its failure to diversify its customers. Most of the bank’s growth came from private equity, health care, and technology, with a special focus on digital assets. A customer base that isn’t diversified can spell trouble if one of the industries the bank is supporting experiences hardship. The same thing can happen with investments.

Even within the same asset class, it’s good to think about diversification. Real estate, for instance, presents a wide array of investment options – single family, multifamily, warehouses, factories, office buildings, and so on. Even when one type of real estate isn’t doing well, that doesn’t mean the entire industry is seeing a downturn. Spreading investments around can help investors withstand any turbulence.

Types of diversification

The most common types of diversification are:

• Asset class diversification: This is synonymous with mixing up your asset allocation between different asset classes.
• Industry diversification: If one industry is experiencing problems, investing in multiple industries can soften the blow.
• Security diversification: Within an asset class, it’s also important to invest in different securities. This can look like investing in different stocks or different types of real estate.
• Geographic diversification: Investing in different regions or countries can help reduce risk based on market trends or changes in economic or political conditions.

How can you allocate assets and diversify your portfolio?

Investors should allocate their assets and diversify their portfolio based on their risk tolerance, time horizon, and current economic conditions.

Risk tolerance and time horizon are both factors that will vary depending on the investor in question. Older investors may be looking for less risk, or they might be looking to catch up and seek investment opportunities with higher returns, despite added risk. Investors looking to get in and out of an investment in 5 years may allocate their assets differently from those who aren’t planning on taking out money for 20-30 years.

Some investors will want to pay attention to economic shifts and business news to allocate their assets. Others will want this done for them automatically, so they don’t have to worry about it. Asset allocation will partially depend on a person’s interest in investing and how hands-on they want to be.

What is rebalancing and why is it important?

Rebalancing is the act of reconsidering and making changes to asset allocation and diversification to ensure it still lines up with an investor’s risk tolerance, time horizon, and desired returns. Some rebalancing can happen automatically with tools like smart portfolios, but investors can also manually rebalance their portfolios.

Even for people who don’t want to micromanage their investments, checking in annually, or when major shifts in the economy may impact your portfolio, is a good idea to ensure things are on track.

What Investream is doing to diversify our assets

“The fox knows many things, but the hedgehog knows one big thing.”

With investments, it’s important to understand the big picture, but it’s equally important to pay attention to the smaller details that form that big picture. It is also vital to stay focused on your strong points and look for adjacent areas of growth. 

Investream is a company mainly focused on multifamily investing. However, when the market shifts and as we grow, we want to be nimble and flexible, responding to what we see and making investments that respond to the shifts. That’s why we decided to add XSpace, a commercial condo space, to the mix.

To learn more about our assets under management, visit our communities page.