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 a car karaoke performance of the latest Billboard song; “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 start a new career as a Pokemon trainer, but because it reminded me about diversification.
First, what is diversification?
Few concepts in finance can get swarms of investors to nod their heads in agreement more than diversification. That is the idea if you spread your assets across various sectors and asset classes, you can capture broad market gains and limit your losses.
You might hear this described as holding uncorrelated assets, or in an even more incoherent manner. What it means is you should hold assets that look and behave differently. A one-stock portfolio doesn’t work, but a mix of stocks, bonds, and international assets with different market caps may.
As a former financial services hack, I’d be remiss if I didn’t insert some corporate jargon. “There’s no guarantee that diversification can prevent losses.” That’s especially true in extreme downturns like 2008 or 2020, but diversification can shield you against most day-to-day or industry-specific movements.
Let’s look at an example. Imagine you held only energy stocks before the 2014-2016 oil meltdown or went all in on Bitcoin at $70k. The following months were likely filled with regret and despair. By chasing returns and putting all your eggs in one basket, you not only lost a significant amount of capital but also derailed your long-term financial goals. It isn’t to say go ahead and invest in as many assets as possible but find a balance.
The Wolf of Pallet Town
Remember Pallet Town? That was where all the excitement of Pokemon Red and Blue began. In the game’s opening moments, Professor Oak asked every new trainer a difficult question, “Which Pokemon do you choose?” You could pick from Squirtle, Bulbasaur, or Charmander. At the time, it was the most difficult decision of my life (I was eight, so not much of a baseline).
Eventually, I landed on Squirtle, and I don’t regret that decision 25 years later. However, I did realize, even at eight years old, that I wasn’t beating the game with just a Squirtle. It was destined to fall at the first encounter with an electric-type Pokemon. I needed to “catch ’em all,” as the song said. Having a diverse team of fire, water, and different element Pokemon would make an otherwise tough battle against the Elite Four a walk in the park.
It’s too bad Ash never learned this lesson. Early in the TV series, Ash gets trounced in his first gym battle against Brock, the leader of the Boulder Badge and proud owner of Onix. Pikachu’s electric attacks bounced off Onix’s tough outer shell, forcing Ash to forfeit the battle and devise a new game plan. There wasn’t much hope here 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, and in Ash’s case, it has come to his rescue more often than not. He often relies on chance to get through tough battles and endless run-ins with Team Rocket. It’s a kid’s show after all, so I guess the protagonist must prevail.
Now imagine if Ash quit training to start a career on Wall Street. With the same attitude—trusting luck and one asset—he’d be on the streets in no time.
A better strategy would be to build a team of Pokemon with different strengths that can withstand challenges from various trainers—from a scheduled gym battle to an encounter in the wild. The same could be said of your portfolio. By mixing stocks and bonds, the most basic diversification strategy, you can fend off your very own wild encounter, perhaps like an unexpected rate hike.
The key in investing and Pokemon is to find a happy medium, whether you invest in various asset classes or capture Pokemon with different element types. That way, you don’t literally “Gotta catch ’em all” to find success in investing or Pokemon.
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