Last week we talked about everyone’s least favorite subject: the COVID collapse. But more importantly, we talked about why it shouldn’t be everyone’s least favorite subject. Like I said in the previous blog posts, facing our fears is important, and it gets easier when we realize our fears aren’t as frightening as we thought. As it turns out, tables turn - and they turn often. Sometimes we are seated in situations that seem less than appetizing, and suddenly we find ourselves in the middle of a make-shift Thanksgiving, feasting and thinking about all the things we are grateful for.
It’s a natural progression: what goes up must come down. Whether it be the market, our moods, or our moods about the market, there will always be twists and turns. The purpose of this series is to help you realize how often negative twists turn into happy endings, which is why we will go over one investment strategy that symbolizes this exact principle: equity diversification.
I’m sure you’ve heard of it before - I’m sure you’ve even heard of it from me. But equity diversification is not something that should be easily forgotten, so here’s a quick reminder.
What is Equity Diversification?
Equity diversification is a strategy wherein investors reduce the risk associated with market movements by placing their investments in various categories that oppose each other.
For example, let’s say you choose to invest in airline stock. If the pandemic has taught us anything, it’s that pilots are not always guaranteed a job. When the virus canceled the majority of flights, airline stock went down. But if the same investor had stock in, let’s say, an RV industry, they might have been able to offset their losses. Remember, what goes up must come down. Or sometimes, when something goes down, something else must come up.
Equity diversification is the process of profiting from that very idea. By placing your investment money in multiple categories, you can protect yourself in the event that one or more categories start to suffer. Chances are, a different type will prosper instead, and the gains you get from their good fortune will cushion the blow of bad luck in another area.
Last week was all about our market's impressive upward movement in the year or so since it bottomed out. To stay on the subject of that example, let’s talk about exactly which sectors started our journey toward the rebound.
When the world shut down, companies and corporations closed their doors to employees. But when one door closes, another one opens, and there was one door that we all shuffled ourselves into more often than we would have liked: the door at home.
We were stuck inside, making make-shift workspaces out of our kitchen tables and children’s crayons. This meant that stock in transportation was among the many to get hit hard by the new hermit crab culture we’d been tossed into. But when something goes down, what happens?
Something else comes up. And since the pandemic, the technology sector has seen a 120% rebound. The stay-at-home system produced by the pandemic did not support the airline industry, railway industry, or pretty much any other mode of transportation. But it did support a sudden surge in online living.
That means that companies would start investing in remote working and learning environments, including advancements in technology that would allow them to store more data, communicate easier, and produce more efficiently.
It’s safe to say; no investor could have seen the pandemic coming. If they did, we probably wouldn’t have believed them anyway. That means that any effort to predict a market collapse as sudden as this one is nearly impossible, the same way it is difficult to predict a dip in a single stock or category. But preparing for a possible decline…that is possible.
Because if investors had had their portfolios diversified, chances are they would have had some of their assets allocated to stock in technology. In that case, the undeniable damage of the market collapse could have been offset sooner rather than later by the demand for digitalization. The best part? This trend where technology is adopted by large businesses is likely here to stay.
We were already on track to a world where technology is taking over. We know that much from the fact that leaving your phone at home feels like you’ve left behind an entire limb. But the pandemic has jolted us into an even quicker era of innovation and development. And as companies work to discover more ways to design new digital products and services post-pandemic, jobs will continue to be created, the market will continue to move up, and as naturally as our mishaps have happened, happiness will happen, too.
In short - keep your head up, keep your portfolios diversified, and keep checking in for next week's post. Until then!
Source: https://www.investopedia.com/investing/importance-diversification/