046 - Diversifying Your Investments! The Best Strategies for Building and Defending Wealth

Unlock the fortress of financial stability through the power of investment diversification. Our latest episode peels back the layers of this time-honoured strategy, offering a rich tapestry of insights on why spreading your wealth across various sectors is akin to building a moat around your castle of assets. Yet, the plot thickens as we invite seasoned investment bankers to the roundtable, who argue for a knight's focus—hone your prowess in one realm of the market before expanding your dominion.

Hear the clash of swords as traditional diversification is put to the test against the sleek, sharp blade of hedging in today's global economy. With everything so deeply entangled, can diversification still stand as the shield it once was, or has the time come to parry with precision? We traverse the battlefield of investment strategies, using real-world examples from the supermarket sector, and reveal how a calculated approach to hedging might be the masterstroke for your financial arsenal.

Finally, don the Armor of discernment as we guide you through the fog of market reports and media spectacles. With a special conversation featuring a veteran investor, we illuminate the path to distinguishing between the smoke and mirrors of sensationalism and the solid ground of factual trends. This episode is not just a trove of knowledge; it's an invitation to join our legion of property market enthusiasts, where we share war stories and strategies to conquer the landscape of investment opportunities.

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Transcript

Speaker 1: 0:00

Should I diversify my investments? One of probably the most contentious topics I have probably ever looked into Well, inside the investing world. So there's a rule of thumb for anyone that hasn't heard about this, there's a rule of thumb about diversification is a really great way to protect your investments and the idea behind it is is that if you have, uh, investments spread over different sectors or in different industries or different investment vehicles, then if some say, for instance, you have a thousand pounds and you divide it into 10 different investment strategies that are in 10 different sectors, then you would have 100 pounds in 10 different places. Then what would happen if, say, one of the industries took a hit, then the nine other ones would would make sure that you have some protection because what affects in one industry is not going to affect the other nine. So the concept they've probably heard that you may be familiar with is not having your eggs, all your eggs in one basket and that just basically means that you're not putting everything you've got on one particular investment paying off or being successful, and a lot of people on face value, you would say, yeah, that's really really clever. That's a really good strategy to mitigate any risk. Because the idea is like why would you want to risk everything on one bet or one move or one play? Why why do it when you can spread it around? Spread around. Look, if technology doesn't do well, then property's going to be fine. If property doesn't do well, then industrials are going to do fine. If industrials don't do well, then consumer products are going to do fine. If consumer products don't do well, then apparel's always good and all these different sort of ways of doing it, and you hear lots and lots of jargon about. You know, do we put it in an s&p 500 index? Do we put it in an etf or a mutual fund or all these other amazing sounding products.

Speaker 1: 2:13

Now, I for many years thought that was maybe quite a reasonable way to play it if you didn't have time to invest, because it would be a case of well, look, you're just sort of spreading your bets around and seeing what happens. And it wasn't until I started to learn more about the investing world outside the world of property investing, and what I came to realize was is that there was a much more vast game at play than what I ever understood or could conceptualize Beforehand. I really just thought there was businesses and there was an investment in certain sort of products and services properties, real estate and so on and I knew you could buy shares in companies. And when you started to look into the depth and breadth of the investment world, you quickly realized that there was a lot out there. So, after looking around, I seeked out the wisdom of people that were very good. So I seeked out the wisdom of some professional investment bankers, and they had a very, very different way of doing it, and what they taught was that you needed to not act like a human being and the reason that they said that is a human being has certain instincts and traits, and those instincts are the things that catch people out when they're investing and the advice that they gave. Because, again, to reiterate the point, what I was actually doing was exploring the entire investment universe. So all the possible connotations, all the possible trading options, all the possible instruments that you could use, all anywhere in the world, any country, any sector, different currencies, equities, foreign exchange markets and so on. So there was a huge amount of information to take in. It's a lot to get your head around. So remember the rule of thumb is to diversify. Diversification is great.

Speaker 1: 4:22

Well, I came to realise that the professionals had a slightly different way of viewing it and, although they do have particular strategies which is hedging your bets, which is about as close as you can get to diversification but there's actually some significant differences is that, when you look at how they approach their strategy, the secret is in what they taught, and what they taught was to become a student of the market. So what does that mean? Well, it meant that you had to understand that you were going through a steep learning curve. That was the first thing. It seemed pretty obvious to me, but I just didn't understand how steep it actually was. And when I realised how steep it was, I thought well, well, okay, that's pretty good, there's a lot to learn, there's a lot to take in.

Speaker 1: 5:10

The natural question is where do you start? Like, where can you possibly start on all this? Because there's just so much of it out there and at the time, crypto was new on the scene. So you've got crypto, cryptocurrencies, bitcoin, blockchain technology, ethereum, xrp, web3, new currency, the fiat systems being challenged and all this information. Just, it was a real um hype of a real hive of activity and a real hype around what would be the new kid on the block. So the first thing that he taught was look, don't become a master in one thing. So go and pick a particular sector or a particular area that you can hone your skills in. So don't try and deal with them all, because if you deal with them all which is a very similar to diversification, which is spread it around you won't become an expert until you focus on one thing and become really, really good at that. What you want to do is become an expert in that one thing, and once you learn the principles and the formulas it takes to become an expert in that thing, then you can start to develop them and use them elsewhere. So things like understanding how the supply chain worked. So what did they actually? Where did this thing come from, this product or service or commodity?

Speaker 1: 6:38

Take, for instance uh see, you've got a phone, so here's a phone here, right for the listeners, I'm picking up an iphone and we go out and buy this phone we use it's a piece of technology, but when you look at the supply chains, there's lithium that came from a mine to make the battery. There's a semiconductor that most likely came from Taiwan. There's camera components that were that were made and assembled in China. And where did the metals and things come from? The the phone to put it, piece it together? So you'll find that there'll be pieces from Taiwan, pieces from China, commodities that were dug out of ground in Australia. You probably got lithium that came from Africa and all these things went together to put in this one phone. I mean, you realize that. You realize that this thing's much, much bigger than you believe, because we look at it, we just see a phone. So what you've done is you started to work out what the supply chain looked like for a particular thing.

Speaker 1: 7:33

So say, for instance uh, your gold's getting a lot of news now because gold's broke its all-time high record for the highest price it's ever been. So say you want to buy a piece of gold or jewelry or a gold billion or a gold bar. You purchase the bar and you're buying it from a broker or a billion dealer. But that billion dealer will buy it probably most likely from the mint or a refinery, and the refinery will then buy that from a miner or someone else within the supply chain that wholesales the gold or from the mining operation that then gets sent to the refiners and that gold miner might be either digging that out of the ground himself and refining the product. As you've maybe seen on the gold rush programs uh, on famous on discovery channel, you will see that that has a process. So before there's you know, land that's getting moved, dirt's getting excavated, it's getting run through a trommel, then that that's then shipped, the tails are shipped out of the back of the machinery to then get this sort of gold-laced sort of earth that's then further refined, and then further refined, and then further refined until he's got these gold flakes. They melt them down to remove the impurities. That then creates a you know a block that they will sell. That then they sell to the wholesalers. They'll sell it to the refinery, they'll refine it and then make it into gold bars. Then it ends up at your bullion dealer and then they sell it to you. So there's a supply chain.

Speaker 1: 9:07

But you wouldn't have believed that. So you wouldn't have believed it was that complicated. But when you start to look at these things you realise there's a degree of complexity that you maybe didn't quite understand and it can be too hard to diversify all your attention to all the things that are out there. What you need to do is hone your attention and focus on one particular thing so you can become an expert on it. And in the case of gold, you would want to understand how gold miners operate, what operating costs that they have. Is that better than investing in gold itself as the commodity? Is there more upside than you know investing and the gold miner versus the you know the gold, the gold commodity, or is there a downside risk? And you know that can relate to many, many factors.

Speaker 1: 9:53

So what you're starting to do is you start with one particular thing and you're spreading out your knowledge to find out where the boundaries and edges of that are, so that you can then become a master or very knowledgeable on that particular thing. What you aren't doing is you aren't spreading yourself too thinly. You're then becoming a student of that particular part so that you can become an expert in that part, and once you do that, you'll work out things like you know the supply chain, start to finish. You work out what influences the price of whatever it is that you're doing, what industry that involves or industries, which sectors are involved, which currency that is traded in and where the main players are in terms of their geolocation around the world. So you'll want to understand things like an easy one would be like, for instance, if you were investing in Africa, if you were wanting to buy a gold mine in Africa. What's the geopolitical situation, how likely is the government to have a coup d'etat or some issues in terms of insurgencies, crime rate, how easy it is to trade, what their court system is like, and so on. So you develop these skills where you become a little detective, figuring out what the processes are that are involved in the thing that you're doing Now, bringing that back, because that's obviously a more complicated version of what most people would deal with unless they wanted to become an investor in multiple asset classes. And you can certainly do that, and that would be a great place to start and certainly leave a link in the show notes to the guys that can show you where to begin. They're very, very good at what they do. I'd highly recommend you give them a visit if that is something that is of interest to you.

Speaker 1: 11:42

But bringing that back where we started with all this is diversification. So when you diversify, what you're doing is you're taking the risk. You're taking the element of danger or perception of taking the risk out of the situation, because the false pretense is that if you diversify your portfolio or diversify your holdings. What you're doing is you're spreading the risk. Nothing will all fall at once, so you're taking the element of risk out to the best degree as you can and in reality, maybe once upon a time that was the case.

Speaker 1: 12:18

But one of the things that have happened over the course of the globalization of the planet is the world has become more connected. So things like telephone networks, uh internet cables, we've now got satellites through starlink that are connecting the world up. We've got wi-Fi that's available in planes. We're using smart devices and apps to transfer, you know, banking information, details and payments at our fingertips. We're even paying with our phone now. So these are things that 10, 15 years ago would have been unheard of, such as the rate of technology. So within that, it's a fast-moving environment and in that fast-moving environment, what we realise is that there's an interconnectedness that wasn't there before.

Speaker 1: 13:05

So the idea of diversifying to spread the risk is that the same as it once was? Or is it as true as it once was? Because when it was true and this idea was sort of thrown around as the way to mitigate your risk, that was in a world that was much less connected than it is now and when you look at it, the connectedness is a big element of. Is that diversification strategy a good play? And when you look at the information in the data, you realise that it isn't, because what you have is, with that interconnectedness, everything's more reliant on supply chains and the connection of different asset classes that now have a degree of connectedness that they never had before.

Speaker 1: 13:57

So the whole premise of diversification is that if one thing fails, it isn't connected to the other nine things that you have that in. And with this new connectedness that we have in the world, that just isn't the case. We have much higher connectedness, which makes things much more influenced, which means that one thing that failed before that didn't affect the other nine. There is now a domino effect that takes place. If you look back at the information that happened in the great financial crisis, you will see that that was the case. It's something that happened in the subprime mortgage market in America caused a topple effect that caused a stock market crash. That caused contagion through industry, supply chains, the bond market, the credit market, the stock market, mortgage market and the currency currency markets. So you can see, the connectedness is now so strong that the idea of diversification isn't what it once used to be, and what I would say to you is is that if you're out there as an investor and you are new learning, or maybe you are pretty developed, as one thing I would make urge you to do is not to be caught up in the trap that if you diversify, that you will just be out of the woods in terms of your risk, because it just isn't the case anymore.

Speaker 1: 15:16

And the bet there is ways of hedging your risk, which is different now to explain what I hate, why hedging your risk which is different now to explain why hedging your risk differs from diversification. So, if you hedge your risk, what you can do is you can take a particular position and a particular item that you think will do well and you can take the best performer in that group and you can think that it will would do amazingly. So the great example that I heard years ago, uh, from the guys at the itpm was uh, say, for instance, you're back in the uk when there was a whole boom of supermarkets. Say, for instance, you wanted to invest in supermarkets and you wanted to hedge your risk in case there was, you know, a crash or a shock or something happened to the supermarkets and you know there was a surprise, what you would do is you would take a position in the best one. So the best one at the time was Tesco. It was the, the main player. You could. You could bet that they were going to do well and one of the least performing ones was Sainsbury's. So you might take a position, thinking that they aren't going to do well and you think Tesco well.

Speaker 1: 16:19

What you're doing is you're hedging your bet. So you are taking your bet on the whole sector, which is the supermarkets, and you are going long or buying an idea on the Tesco side, which is the best performer, but you're covering off. You're betting that Sainsbury's won't do well and that means that if there is a market shock, sainsbury's will go down, which means you'll get paid for that because you've thought that they would underperform by shorting them and then that would cover your loss that you might make from tesco falling. And one of the things that you find that hedge fund guys do is they monitor the best performer is likely to go up higher than the worst performer, so that creates the gap or the performance. But when things go down, they tend to go down quite uniformly. So if there's a drop, they tend to drop and everything drops at a similar rate. And that's the idea of hedging. And you can do that on different sectors, you can do that in different currencies and various strategies.

Speaker 1: 17:19

So hedging is a very specific way of measuring. If it does go, if it does go against me, then what's the best way to play that? And that's very different from diversification, because diversification is right. I'm just going to spread it out and hope for the best. So there's a lot more analysis and thought that goes into hedging your risk than diversifying your risk, and this is where a lot of financial advisors and a lot of people that are well-meaning in terms of their advice are looking at the past, when the world wasn't as connected, thinking, hey, diversifying is a great way of managing your risk.

Speaker 1: 17:57

What you want to look at is the expert guys that are trading the big bucks and how they looked at it and the differences between them, because hedging a risk and diversifying a risk are worlds apart, and the best performing asset managers are proof of that, because they are handling tens, if not hundreds, of billions of pounds or dollars and they're taking huge positions where they're using these strategies to great effect to cover the risk that they're planning on taking. But what they do is they become an expert in their field first. So they become an expert at what they do, one particular thing, and then, once they've learned that craft, they can then lay that out to all the other different component parts. And that is very different to someone that just says, look, I've got a thousand quid and I want to put it in 10 component parts, and that is very different to someone that just says, look, I've got a thousand quid and I want to put it in 10 positions and hope that it works out, because there's just little thought, little analysis that goes into it.

Speaker 1: 18:53

If you want to become very, very shrewd at what you do, then become very, very good at one particular thing that you can start in property. You can start in currency. If you that you can start in property, you can start in currency. If you like, you can start in commodities, you can, whatever the particular thing is you wanted to pursue. Whatever your interest is, and an easy one is property. The reason property is the easiest is, first of all, it's the most tangible. So you know what it is that a property represents, like some of the instruments can be abstract and it's difficult to understand and you don't really know how the contracts put together and so on. Are you buying the contract or are you buying the physical thing? Do you have a share or don't you have a share? Do you have a contract on a share of the underlying assets, on it's hugely, vastly complicated um, that complexity can be understood and it can be learned, so don't let it put you off. But, relative to property, it's very, very straightforward to understand and when you have the property market, uh, you know what a house is.

Speaker 1: 19:55

There's a lot of historical data that you can review. You can review the crashes and recessions to find out what happened. Then you can understand what happened leading up to the crash, you can understand what happened during the crash and you can understand what happened after the crash. So you can lay a mosaic of what happened and you can look at the conditions to see how they played out. And that's a great place to start, because it's in something that you can look back in time to see what happened. You can see what caused it and you can actually work out what you would have done if you were to simulate that event. And you don't. You can work out the answers based on the historical information that you've seen, and that's a great way of getting a real handle on how markets work. And I would urge anyone that's interested in this to take a look at previous history, because, although history doesn't repeat, it sure does rhyme.

Speaker 1: 20:50

I've done a podcast recently where I explained that the way things are looking in the property market and the wider industry as a whole in terms of the business cycle and the you know the, the full market things don't look identical to the way they did in the last crash, but they're leading to a similar place, and it's only through understanding what happened previously that you can then draw conclusions on the similarities or the things that will lead you to the same place that maybe look slightly different to before. And if you want to become an expert in any multiple disciplines, first thing you do is you become an expert in one a great place to start. Should you want to do that, I've got a property course where I show you the basics of this. I show you how to understand the business cycle, why it's important, what are the type of deals that you should be doing in that business cycle, how to approach it, how to analyse and understand it, and if you like that sort of idea and you want to come along and you want to be coached weekly with some weekly coaching calls, check out the links in the show notes. You can get involved and you can be along for the ride.

Speaker 1: 22:13

I'll also show you how to read reports and media articles where they may give a suggestion that they're spun in a certain way and how to identify when it's been spun to lead you to think that the market is either improving and where to decipher is it true or is it false. We've also got a property community. So if you like all these sorts of things and what's exclusive access and some content that is a little more detailed and can give you the information you're looking for, come and join us and we hope you enjoyed this week's episode and conversations with an investor from me this week. That's a wrap.