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- Diversify Your Pizza
Don’t put all your eggs in one basket.
That’s what everyone says.
It’s like a pizza - you want to spread the toppings all over.
In investing, it’s no different.
If you invest everything into one asset, and it fails, all your money goes bye-bye.
Diversifying your investments through asset allocation is a mantra repeated by countless professional wealth managers, and for good reason - they want you to increase your chances of growing that wealth over time, without one major incident destroying that beautiful Neopolitan pizza.
"The most important key to successful investing can be summed up in just two words-asset allocation."
First, let’s talk about asset allocation. It’s the process of dividing your investment portfolio among different asset categories, such as stocks, bonds, and cash.
Like the pizza from earlier - you decide how much cheese, sauce, and toppings to put on it. Determining which mix of assets to hold in your portfolio is personal. An asset allocation that works best for you NOW will depend largely on your time horizon and your risk tolerance.
pizza pie allocation
Timing is Everything
Your time horizon is the expected number of months, years, or decades you will be investing to achieve a particular financial goal. This could be a home purchase, upcoming retirement, or building up an emergency fund. Everyone’s time horizon is unique and a critical component of their asset allocation.
An investor with a longer time horizon may feel more comfortable taking on riskier, more volatile investments because they can wait out slow economic cycles or market declines. On the other hand, an investor with a shorter time horizon may prefer less volatile investments that provide more stability.
Riskier assets may include stocks, alternative investments, or even cryptocurrency. Less volatile investments may include fixed-income investments like bonds, money market funds, or CDs.
All of these involve some volatility which is important to consider. This refers to the variation of an asset’s price over time. Investments with higher volatility are considered riskier than those with lower volatility. This is like my favorite rollercoaster at Cedar Point - a huge drop with various ups and downs. Others may want to ride the carousel.
sample allocations
sample allocations
A Keen Eye
Once you’ve settled on your risk-comfort level and time horizon, don’t just set it and forget it.
An asset that grows considerably over time may start to become a larger proportion of your overall portfolio. You could leave it alone, but that may deviate from your original strategy. That one egg is growing too big perhaps.
It can be worthwhile to decrease the amount of that asset and put it into the others - this is called rebalancing. Investor.gov has a great article on this subject. It describes rebalancing as: “when the relative weight of an asset class increases or decreases more than a certain percentage that you’ve identified in advance.”
The most important thing you can have is a good strategic asset allocation mix. So, what the investor needs to do is have a balanced, structured portfolio – a portfolio that does well in different environments…. we don’t know that we’re going to win. We have to have diversified bets.
Diversify your Pizza
Spreading your investments across different assets also does one more important thing - reduces your overall risk.
If you place all your pizza toppings on one slice, and that one slice gets burned, then your pizza is ruined.
But if you spread all your toppings across the surface area in an even manner, that one burnt piece won’t matter to you - you still have several good slices of pizza, ready for your enjoyment.
Save On,
Chris