The ups and downs of portfolio diversification in the "dating" market
“When structuring an investment portfolio, received wisdom declares it prudent to diversify. In a diversified portfolio, by definition, the various categories will out-perform or under-perform depending on the market environment. So, a diversified portfolio never truly maximizes on any given market; its structure is designed to perform modestly well in nearly all circumstances.”
- Richard Mock's "Money Lures" from:
"Show Me the Money, The Dollar as Art" Exhibition 2002-2003
This being RRSP season, I recently met with my financial advisor to go over some of my investment options for the upcoming year. Not that I have tons of money or anything, but it’s always a wise thing to both plan ahead and occasionally take stock of one’s current financial situation to make sure we are moving in the right direction. One thing my financial advisor does once in a while is assess what he calls his clients’ “risk tolerance.” By that, he means determining how aggressive or conservative you are when it comes to investing your money. Do you feel comfortable placing large sums of cash in riskier investments that have the potential to give you much higher returns but at the cost of greater risk? Or do you prefer to place your money is safer investments like savings bonds and GICs?
Of course, nobody is ever really either a fully gun-ho risk-taker or a constantly fearful and risk-averse penny pincher who would rather keep their money under a mattress or a savings account. Most people prefer a combination of safer and riskier investments. As the old saying goes, never put all your eggs in one basket. That’s where the concept of “portfolio diversification” comes in.
The wisest thing is to spread your assets between a series of moderate to more high-risk investment options. As my financial advisor says, your risk tolerance will change throughout your lifetime based on where you are in life and what your priorities are.
As we were having that conversation about portfolio diversification, I couldn’t stop laughing in my head because a group of my guy friends and I often use the “portfolio diversification” concept to analyze our dating patterns.
All of us on the crew are in different stages of dating investment strategy. The married guys are the ones who have now placed all of their equity into a fixed-rate mortgage. This is, in principle, a long-term investment of 25 years to a lifetime. Then, there are the singles guys like me who are still playing the market. For us, the single guys, portfolio diversification is the name of the game. Until we find that suitable high-interest-yielding non-transferable savings bond that we can eventually invest into a mortgage, we dabble in stocks, mutual funds and even GICs (Guaranteed Investment Certificates).
In our portfolio diversification lingo, Sister#3 from my blog is a volatile stock. We call her “Nortel Networks.” For those of you not familiar with the volatile history of this Canadian technology company, back in the mid-to-late 1990’s Nortel Networks stock was the darling of everyone. The price of the stock kept inching up further and further as the company went from success to greater success. Then, the bubble crashed. Tons of workers were laid off, and the stock plummeted. Thousands of investors lost their shirts. There were accounting scandals, and heads rolled. More recently though, the company seems to be coming out of their doomsday period. Leaner and meaner, armed with new management, they promise a bright future once again. It remains to be seen.
As you may recall from my blog, my experience with Sister #3 (Nortel) was somewhat similar. Much like Nortel Networks, I came to know her over a year ago as a high-valuation stock in my circles’ dating market. A lot of my friends talked about her as an attractive stock with lots of portfolio growth potential. She can walk into a room by herself and turn heads. She sure isn’t a junk bond because her fundamentals are solid. Educated with an unmistakable aura of sophisticated sexiness, she was a must-have in my portfolio. But, again, as I explained in the blog, the stock crashed very quickly and unexpectedly from the very first date. Nortel’s rapid devaluation left me totally a gasp and confused. I was facing a very aggressive market with strangely very little room to engage in even productive conversation. So I quickly abandoned my Nortel stock.
In a strange twist of events, however, not even a couple of months later, Nortel was offering a new IPO (Initial Purchase Offer) and started calling me out of the blue to buy in again. Once again, the fundamentals over the phone seemed very strong, but I was very weary about investing in Nortel again. However, since I received the new Nortel Networks IPO right after I had cashed out of my Charlotte GIC following lower-than-expected returns, I decided to reintroduce Nortel into my portfolio.
Much to my delighted surprise, Nortel has been keeping on largely exceeding my own market expectations ever since – now five months later. We actually had a board meeting between the two of us at a restaurant, and I was pleasantly surprised when Nortel disclosed a full audit of the reasons behind her unexpected valuation crash during the previous quarter. Her honest and genuinely apologetic report, which came about completely voluntarily and without any outside compliance pressures, was a very welcomed breath of fresh air. Usually, high-valuation stock companies aren’t in the business of justifying their market downturns. But our internal audit process, which has since become a two-way street, was most beneficial.
Despite all that, though, I must say that although I have fully forgiven Lady Nortel for her unexpected stock crash, I am still concerned that it could have ever happened in the first place. What would stop it from happening again? Undoubtedly, as the stock keeps performing well, I can definitely see reinvesting some of the lady Nortel capital gains into a high-yielding GIC and even a mortgage.
I am still analyzing the stock.
Although my Nortel stock now figures prominently in my portfolio, it is still part of a mutual funds category, which also includes another amazing stock that I was referring to in Part I of this article and that you haven’t yet met.
I call her Lady Google.
Of course, everyone is familiar with Google. The term Google, referring to the popular online search engine, has even made the dictionary as in “Googling” someone. Much like the real Google, my lady Google started out as a project. Actually, our initial interactions, starting towards the end of this year’s first quarter, were work-related. Even though Google was evidently very attractive from the time I met her, any dating impulses I had were superseded by Lady Google’s outstanding functional capabilities as an effective business partner.
My initial restaurant board meetings with Lady Google started mainly with searches involving words like “efficiency, planning, and feasibility.” But as our interactions began taking place in other, more relaxed settings, I started Googling words like “shows, movies, dates” and got some great search results. I started developing a whole new set of bookmarks, and before we knew it, the homepage of our relationship had changed.
Needless to say, the market unanimously agrees that Google is a hot stock. With no visible sign of a crash in view, Lady Google’s stock valuation rose exponentially. Lady Google even attended a home audit at one of my friends' headquarters, with many of the major shareholders in my group of friends present, and very much impressed them with her fundamentals. Soon, my portfolio became much less diversified, and Google began looking like it could become the sole beneficiary of all my assets.
But what about Nortel? The future projections of that stock, despite a troubled history, looked excellent as well. On the other hand, complications loomed over the feasibility of purchasing exclusively Google stock. Some of the Google stock portfolios were quite suddenly migrating to another stock exchange out of town. Google’s stock migration, temporary or not, meant that I would need to look at them as future purchase options -- since I am currently unable to purchase any stock out of town. Moreover, I am not even sure if I would be entirely willing or even allowed to purchase the foreign Google stock anyhow, given the circumstances. Merger and acquisitions discussions with Lady Google weren’t yet at that level when the Google stocks moved out of town.
So, in the final analysis, various factors, some within and some outside of my control, have allowed me to continue exploring my portfolio's diversification dating strategy. But as the quote at the beginning of the article says, “a diversified portfolio never truly maximizes on any given market.”
