If you are like me, you probably made it a point to catch the newest episode of Pokemon every morning before school. You would recite the theme song with a sense of pride and confidence matched only by the latest song on the Billboard charts; “I wanna be the very best, like no one ever was… , Pokemon, Gotta Catch ’em All.” Those last four words recently struck a chord with me, not because I wanted to play Pokemon again, but it sounded similar to diversification.
Having a diverse team of fire, water, and electric Pokemon can make an otherwise tough battle against the Elite Four a walk in the park. This is evident early in the series when Ash gets trounced in his first gym battle against Brock. Pikachu’s electric attacks did not affect Onix’s tough outer shell, forcing Ash to forfeit the battle and devise a new game plan. He didn’t have much hope without a stable of grass and water types. Yet, Ash makes the hasty decision to try again, and with some good fortune, he defeats Onix.
Luck can be a great equalizer in the absence of preparation, but in Pokemon battles and investing, planning ahead reduces the impact of unexpected events. The best strategy is to build a diversified team of Pokemon or investments that can withstand most challenges encountered in the wild—like a gym battle with Brock or a market downturn.
Far too often, though, Ash relies on chance to get through risky battles and endless run-ins with Team Rocket. It is a TV show, after all, so the protagonist must prevail. Now suppose Ash quit training to start a career on Wall Street. With the same attitude, built on hunches and a singular asset, he’d be on the streets in no time.
First, what is diversification?
The first, and perhaps most important, lesson investors learn is that diversification may reduce risks and boost returns. Reaching this investment nirvana requires a mix of investments that vary in size, industry, and geography. In the past, that was a healthy mix of domestic stocks and bonds, two assets with historically uncorrelated returns, but lately, the relationship has strayed from its original intent. When one of them is zigging, unlike what theory suggests, there is a good chance that the other is zigging as well.
Achieving true diversification may now call for a mix of domestic large and small-cap stocks, emerging market stocks, developed market stocks, domestic bonds, and some cash. Each asset exhibits a low correlation with one another, so holding this mixed bag can reduce portfolio risk. Still, there’s no guarantee that diversification can prevent losses in extreme situations, but it does shield against most day-to-day and industry-specific movements.
Let’s look at a recent example. Imagine you held only energy stocks before the most recent oil meltdown (2014-2016) or doubled down on Bitcoin in December 2017 without any protection. The following months were likely filled with regret and despair. By chasing returns and putting all your eggs in one basket, you not only risked a significant amount of capital but also derailed your long-term financial goals. That’s not to say go ahead and invest in as many assets as possible. Instead build a thoughtful portfolio with varying characteristics.
Pokemon takes a walk down Wall Street
Ash has traditionally shunned diversification for a one-size-fits-all approach. He starts most battles with Pikachu, and when the battle reaches its apex, and other Pokemon are still fresh, he makes an impassioned plea to his yellow friend to save the day. More often than not, it works. But Ash could avoid these foolish moments by training Pokemon with various strengths and weaknesses. Just like our hypothetical basket of stocks above, which will jump around less than a one-stock portfolio, Ash can throw Bulbasaur, Squirtle, or Charizard at any of the foes he encounters in the show.
The key is to find a happy medium between risk and reward, just as a Pokemon trainer strikes a balance between different element combinations. That way, you don’t literally “Gotta catch em all” to find success in investing or Pokemon.
Take me to more content combining finance and entertainment.