I am sure you heard about the soaring of some unlikely companies like GameStop last week. In fact, the New York Times claims amateur investors are "Beating Wall Street at Its Own Game" with shares in GameStop skyrocketing 1,700% by end of day Monday, Jan. 25. In part, some of this activity appears to be tied to social media users on Reddit identifying the stocks as short sale opportunities.1 Other heavily shorted stocks, like AMC, Blackberry, and Express, have been affected by this dynamic at the end of January as well.
Talking with friends who got in early on the action or seeing social media shares about amateur investors doubling their money can leave anyone wondering, "Should I be reallocating my investments?" As we continue to watch this story unfold, here's a reminder about what diversification means for your portfolio.
When it comes to diversifying your investment portfolio, it’s important to evaluate all sides of the strategy before committing to one approach over another. When it comes to proper diversification, it’s important to allocate your money according to valuation, not some overly-hyped Wall Street formula or changes in the news. This may result in you holding onto your money when good deals aren’t necessarily ready and available.
While investment professionals often recommend the approach for its ability to reduce risk and volatility, it could also minimize the level of returns generated. When determining the extent you should diversify your portfolio, consider your own personal investment objectives, preferred risk tolerance, and strategy options. Even professional investors often neglect one important part of diversification, which is diversifying your wealth into different financial jurisdictions.
Diversifying Your Portfolio
As mentioned previously, reducing risk is one of the key reasons you might decide to diversify your portfolio. While risk can’t be eliminated entirely, diversifying your portfolio can help you manage your overall level of risk and minimize your chances of losing large sums of money over time. When you don’t diversify among your asset classes, you become even more exposed to market risk.
To go along with reducing risk, diversification also allows you to hedge your portfolio, which is an automatic benefit of refraining from putting all of your eggs in one basket. By investing in a variety of sectors, you even out your chances of getting positive and negative returns, as opposed to purely negative.
An alternative to capital appreciation, capital preservation is another benefit of diversification. Instead of focusing on your rate of return, capital preservation is all about protecting the money you already have.
Diversification is usually presented as investing in a variety of asset classes and making it easier to protect the wealth you’ve already saved and accumulated. While this certainly holds true, I would also like to discuss how you can expand the level of diversification you have in your total wealth by moving part of your money offshore.
Adding an International Aspect
Where many explanations and understandings of diversification are falling short is when it comes to diversification in terms of financial jurisdiction and consequently currency. Even if you have a well-diversified portfolio with your stock broker in your home country, chances are your positions are almost exclusively in the US stock market and the US dollar. Over the past decades, the US dollar has steadily lost value. Especially in 2020, we saw steep declines.
For example against the safe-haven currency Swiss franc, it lost 9%3. International investments are extremely helpful in geographically diversify your wealth. How can you gain access and expertise in these other markets? In most cases not through a US broker. Sure, a few boutique firms specialize in international shares, but to experience the full richness of international markets, an offshore bank account and an independent asset manager based in another geographical region are a huge benefit because it makes your wealth less dependent on your domestic currency and the developments in your home.
Now back to the initial topic of Reddit traders. The unusual activity we're seeing with these heavily shorted stocks like GameStop, AMC, and Blackberry are creating big headlines in the news, but that doesn't necessarily mean it's cause for reallocation within your own portfolio. With steep profits, we often also see steep losses. In the long-run, you are almost always better off putting together a nicely diversified portfolio that takes into consideration your financial situation, risk tolerance, and time horizon.