Never invest in anything that could cost you your life. Now I don’t mean cigarettes or other harmful items, but by making the mistake of investing so much of your capital in a venture that its failure may knock you over. This is the essence behind diversification. It is an essential element of a sustainable portfolio, designed to meet the rigors of life and the challenges facing our markets and economies.
Most people want permanence because it symbolizes utility and represents stability. If we depend on something, we want to know that it will be there for us when we need it most. Equipment, clothing and gear are all things we need to depend on when running. Your financial plan and portfolio should be no different. But how do we prepare our portfolio to stand the test of time? What can we do to build some flexibility and strength in our investments and even how we invest? Here are some of the methods we use to improve the sustainability of our portfolio:
Expand your time horizon: One of the best ways to increase your chances of success is to expand your time horizon. The longer your time frame, the more opportunities your portfolio has to avoid any obstacles or injuries along the way. This is true for almost all asset classes, and intuitively we all know it. Investing in stocks, real estate, or businesses — whatever the asset class — you’ll find that the longer your horizon, the higher your confidence. This is an unfair advantage. Alternatively, the shorter your time frame, the greater the uncertainty. Durability is tested over time. When investing remember that time is your ally.
Never invest more: Never invest more than you can comfortably handle. Be it buying a home, business or anything else, invest up to the level you are comfortable with. Putting too many of your proverbial eggs in one basket not only reduces the stability of your portfolio but increases the risk of a total wipeout. Instead, make a plan toward your goal. Invest enough to achieve your goal and let the time work on your plan.
Diversify your financial assets: There is some truth that wealth can be built up by the massive concentration of your portfolio. There are billionaires whose entire net worth is invested in their company. We describe them as “all-in-one” investors. This is not a strategy for most of us, nor a healthy way to build an investment portfolio. I use the “kill amount” metric when thinking about diversification. In other words, don’t put so much faith in one investment that if it blows up, it will kill you. Likewise, if you don’t have enough business, you might miss out on a killing. I think diversification means owning 20 to 25 different businesses that are understandable, trackable and worth owning.
Don’t overdo it: A good, durable jacket is rarely fussy or complicated. Your investment should be the same. Consider owning a portfolio of businesses that sell products and services you actually use and have experience with. We are a great believer in consumer product companies because of their durability through all economic cycles. In good times and bad people buy and use consumer products like toothpaste and ketchup. The market may crash tomorrow, but people will still need toilet paper. Remember that simplicity is often characterized by durability. Know what you have.
It works, even when it doesn’t: Engineers build in fail-safes when an object has to work, like an airplane or a climbing rope. As the name implies, these fail-safes are designed to kick in when other parts fail. Diversification goes a long way toward meeting that goal, but we encourage investors to consider dividend-paying companies with a track record of consistent payouts no matter the market. This means that the market can move up, down or sideways without affecting the income that companies get from them. Of course, a company can always modify its dividend, but we like those who avoid doing so at all costs. Did they continue to pay their dividends through the dot com crash or the Great Recession? That’s the definition of sustainability to me, and I want to own it.
Avoiding Accidents: While durability is often measured by an object’s ability to come out of accidents, we need to minimize accidents as much as possible when it comes to our finances. To make mistakes is to be human, but when we allow emotions to influence decisions, we run the risk of ruining the stability of our portfolios. In many ways, we can be our own worst enemy if our investment decisions are dictated by our feelings of panic, fear, or greed. While we may not be able to avoid feeling them, that doesn’t mean we need to be guided by them. Your financial plan is your guiding light. Use this to guide your investments, and don’t let the daily volatility or the flurry of market opening change your course. Over a fairly long period, the market has always recovered from the occasional crash.
Remember, a durable portfolio is only as flexible as the person managing it. There are steps you can take to build a stronger, more sustainable portfolio, but it will be your job (or the person you assigned this task) to pilot them through a rough patch. Your challenge is to understand how your portfolio was built to withstand repeated bruises, bumps or scrapes, knowing full well that it was built to last.
Steve Buren is the founder of Prosperian Financial Advisors in Greenwood Village. He is the author of “Intelligent Investing: Your Guide to a Growing Retirement Income.” He has been named by Forbes as the 2021 Best-in-State Wealth Advisor and Barron’s 2021 Top Advisor. This column is not intended to provide specific investment advice or recommendations.