Diversification: The Key To Sanity
Our picture of the stock market seems complicated. There’s buying and selling going on. There are winners and losers. Lots of bells are ringing and people are yelling. There are these elusive men dressed in pinstripe suits down on Wall Street, sitting in large conference rooms overlooking the Manhattan skyline, talking in a tongue we don’t understand. Or so we think…
At a base level, the stock market is really just a collective reflection of what we think the valuation of certain companies, and the aggregate markets, are. It’s our psychology mapped against numbers.
The mechanics and systems are a bit more complex, but in its simplest form, the people who win in the market are those who understand what it’s actually signaling.
As Warren Buffet has said, “Be fearful when others are greedy and greedy when others are fearful.” The market is merely a reflection of the mob mentality; to win you must bet against it. And do as the old adage says: when prices are low, buy; when prices are high, sell.
So many of us “know” this, yet only a few of us are winning. So many of us fall into the "others" camp that Buffet describes. Why? Why can't we seem to put this adage into practice and flip the market on its head?
Short answer: undisciplined fear.
Most of us are far more afraid of losing what we have than we are excited at the prospect of gaining what we don’t. Economists call this behavior “loss aversion.” It means that most people tend to want to avoid losing $5 more than they want to risk winning $5 (for example).
And so, we act emotionally not logically when the Dow falls. We freak out, sell, and lose.
Logically, it doesn’t make any sense given the old adage. But at the time, for us, it does. Our survival instincts kick in. We don’t want to lose any more than we already have. So we pull all our money into cash reserves.
Yet, the greatest opportunity for any growth -- in joy, success, fulfillment, money, whatever -- is always in the opposite direction of fear. It’s where others are unwilling to go.
The problem is that so many of us rely on our moment-to-moment decisions to get us there. We fail to discipline our minds, our disappointment, our actions, and our egos ahead of time. And at the moment something goes wrong, we will always be biased towards comfort.
Combating this illogical mechanism starts with accepting that uncertainty, volatility, and losing are a part of life. Even the best investors lose big sometimes. Even the best athletes miss shots. If you aren’t willing to lose, if you aren’t willing to have your heart broken, if you aren’t willing to be a bit vulnerable, you can’t expect to experience great success, love, or joy either.
If you choose to accept this reality, however, there are ways of managing the fear so it isn’t so debilitating.
In investing, they call it diversification. You create a portfolio of low-risk (stable-reward) and high-risk (potentially higher reward) investments based on your level of risk aversion. You never put your nest egg in one basket; you split it up across different asset classes. That way, if one asset tanks, you have some others to back you up. You still have something going for you.
As this idea applies to life, I call it “ego diversification.” You invest your identity points in a number of different things, so if one bad thing happens — like you break your leg or break up with your partner — life still continues on. It sucks, but your mind still works. You can’t run and you’re heartbroken, but you can still write, for example. You still have something going for you.
This makes it so you aren’t completely tied to success in your career, investments, or success in your relationship. It takes the pressure off of every good thing in your life so that each has the space to become what it was meant to.
With a diversified ego, investments of time, heart, and money are important, but none are the end all be all of who you are becoming. You know that life will not end based on one bad thing happening. And so, you are free to take your chances with love, career, travel, or whatever else.
This diversification makes you more comfortable with the fact that you will lose sometimes. People will die. You will get your heart broken. Things will fall through. You will experience your own depressions and recessions. Life generally sucks sometimes.
In times of stress, you'll know it's up to you to fight the urge to pull out of the life (or the market). To not sell off all your shares, take a breath, and rebalance your portfolio.
Remember: all of life is just a psychological game we are playing with ourselves. It’s like the market, just a projection. Nothing is quite as bad as it seems at the time. It's just our short-sighted perception of it.
Throughout history, every major economic recession and depression has been followed by a period of insane growth and expansion.
And that's why you must diversify and discipline. The best stuff is born of the worst.