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When it comes to investing, you are much better off holding a globally diversified, low-cost portfolio than you are making concentrated bets on individual stocks or asset classes. Unfortunately, many investors do not see the value of diversification in their investments. And perhaps that isn’t surprising, considering the many ways in which society encourages putting all your eggs in one basket.
Take the growing trend in youth sports known as “early specialization.” Children as young as 7 start training exclusively in one sport, often because their parents believe it will help them land a college scholarship or lead to a career in professional sports. In effect, it’s a concentrated bet on the child’s future in sports.
But specializing in one sport at such an early age comes with great risk — just like putting all of your money into one stock. The similarities between this dangerous youth sports trend and the hazards of an undiversified portfolio are striking. And the data show that in both fields, variety trumps specialization.
Here are four ways that a lack of diversification in your finances parallels the effects of forcing your child to specialize in one sport at an early age.
1. Worse performance
Lack of diversification usually results in underperformance, both in the markets and on the field.
Investing: Since 1950, a blended portfolio of U.S. and international stocks has slightly outperformed the S&P 500, the benchmark for U.S. stocks, according to research from Fidelity. And the globally mixed portfolio achieved its returns with less volatility than U.S. stocks. That means if you had invested in just the U.S. market, your portfolio wouldn’t have done as well, and you would have suffered through greater ups and downs.
Sports: A study of 708 players in baseball’s minor leagues — where tomorrow’s major leaguers hone their skills — found that only 25% of them specialized in baseball at a young age. Additionally, those who waited until their teens to specialize were more likely to win college scholarships.
2. Greater chances of permanent damage
The goal in both investing and sports is to live to fight another day. Specialization reduces your probability of survival in both fields over the long term.
Investing: Since 1980, roughly 40% of all stocks in the Russell 3000 have suffered “a permanent decline from their peak value,” according to research from J.P. Morgan. (It defines a permanent decline as a loss of at least 70% of the peak stock price, followed by a recovery that’s minimal at best.) This means the chances of losing most of your money would have been much greater if you were picking individual stocks. While a globally diversified portfolio made up of low-cost index funds would have had its ups and downs, the odds of permanent losses over long stretches of time are very small.
Sports: The possibility of permanent injury is much greater if your young child plays one sport exclusively for eight months or longer. Medical studies have shown this significantly increases the chances for stress fractures and other repetitive-use injuries in young athletes.
3. Danger of following the crowd off a cliff
In both investing and youth sports, it’s often a very bad idea to do something just because everyone else is doing it.
Investing: Following the crowd can lead to great heartache. Think of the dot-com stocks of the 1990s and the overinflated real estate values of the early part of this century. Most investors thought they could get out before these massive bubbles burst. But in both cases, too many rushed for the exits at once. The hopes of getting out before the crowd did were crushed, as were the portfolios of many participants.
Sports: Youth sports have become another way for families to keep up with Joneses. Instead of looking at the danger of 12-month athletic seasons on their children’s emotional and physical health, many parents ignore the risks and push their kids to keep up with other young athletes. Travel teams and the like have become status symbols with an allure that can overwhelm common sense.
4. Emotional trauma
Focusing too intensely on one thing can be damaging to the emotional welfare of everyone involved.
Investing: When investors buy a few individual stocks or invest in a high-flying sector, they tend to track the market’s daily or even hourly movements. This often leads to sleepless nights, loss of appetite and frayed relationships. Contrast this with owning a global portfolio of low-cost index funds that you check and rebalance once a year. This strategy provides higher returns, lower risk and greater peace of mind. And think of all the time you save when you aren’t monitoring the markets every day.
Sports: Specialization in youth sports brings its own emotional baggage. Many parents invest an enormous amount of time and money — and they expect results. This can backfire, with their children believing their parents’ love is contingent on their athletic performance.
Young children should have the opportunity to try a variety of sports; this often leads to better athletic performance, a healthier body and a less stressful environment. Similarly, your portfolio should have a healthy mix of low-cost, global investments. You may not capture the outsize gains that a few lucky stock pickers will, but over the long run, you’re less likely to suffer devastating losses.
Physical or emotional harm to your child and permanent losses in your portfolio should be avoided at all costs. So don’t ignore the benefits of diversification for your young athlete or your investments.
This article also appears on Nasdaq.
Image via iStock.