Remember those early soccer days when the kids would congregate around the ball in one big mass kicking it nowhere. Nothing really happened other than the coaches yelling at the players to take their positions to no avail.
As the children matured and developed discipline, they would stay in their assigned positions and all of a sudden the field opened up. Movement occurred, they were prepared to take advantage of changes on the field and scoring goals became a real possibility.
The investment world is not all that dissimilar. The basic concept of diversification is to create dissimilar investments that are strategically positioned to take advantage of the “soccer ball” when it comes your way. Chasing that ball is just that…you rarely get ahead of it, infrequently ready for the action to come and often times not in a position to maximize results.
The recent price increases in oil represents a good example of this. Now that it has become headline news, let’s predict the story and investor behaviors that might unfold…a movie we have seen before. For an educated guess, the news media may focus on middle east instability over the next several weeks (that’s a shocker…it’s only been that way for our entire lives). Then scene two might focus on China’s insatiable appetite for oil only to be outdone by the U.S.
Then the oil companies and traders could be the next most logical focus of blame for price hikes as they must be manipulating the markets along with the overseas producers. Then the government is usually next in line. Bush was previously blamed because his administration “must be” helping his oil buddies? This time around the same prices hikes will be due to another reason. Gotta love the hypocrisy.
As the frenzy gains speed, we can only imagine that oil prices will be prognosticated by the same people that sensationalize all the stories to go to $5, no $6, no $8 dollars a gallon…who knows how high. It will surely be labeled as “scary” times and flash back parallels to the 70’s will inevitably follow. We can only imagine the media will attempt to portray this as the end of any sort of economic recovery. The higher the price, the more fear that can be sold.
On the investor front, that fear probably translates into greed. Can’t miss out on this run up, right? The sky is the limit. The higher it goes, the more confident people will be that it will continue that trajectory. The gold commercials will undoubtedly throw in some oil if you want that, too.
We have absolutely no idea where the price is going to go and no one else does as well with any certainty. How do we know that? Because we have spent enough time with some of the “smartest” people in the financial industry to know what they don’t know (you would be surprised).
To keep our heads in the game smartly and gain some perspective for consideration, we have been her before. Starting in 2000, the price of oil went from the $40 a barrel range to $140 in 2008. In 2008, it was story after story about oil going to $200. Well, it dropped in price over the next year for all that it gained over the previous eight. Stories ended.
In theory there is no limit to how high the price can go. But realistically there is one because at some point, the demand falls as it becomes unaffordable. While the price can go up, up and up, it can also reverse course quickly (the nature of commodities). That is why we often write about how important it is to asset allocate your portfolio and rebalance regularly. It naturally forces you to sell assets which have appreciated faster than others and buy those that have lagged (some argue…sell high and buy low).
The lesson to learn is that while you may be enticed to chase oil as an investment, it probably was more advantageous and profitable if you would have been positioned like a professional soccer team ahead of time. Being ready before the prices jumped in the first place. The “ball” constantly moves around the field…where it goes next is dependent on an endless array of human and natural actions yet to materialize and still subject to tremendous uncertainty. But when the ball moves, will you be ready for it?
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Author’s Note: Brad Stark, MS, CFP, AAMS, CMFC and Seth Streeter, MS, CFP, Co-Founders of Mission Wealth Management, LLC, a Registered Investment Advisor. The information contained in this article is general in nature and should not be construed as comprehensive financial, tax, or legal advice. As with any financial or legal matter, consult your qualified securities, tax, or legal representative before taking action. Securities offered through National Planning Corporation, Member FINRA/SIPC. NPC and MWM are separate and unrelated entities. Certain statements contained within may be forward-looking statements, including but not limited to, statements that are predictions of or indicate future events, trends, plans or objectives. Undue reliance should not be placed on such statements because, by their nature, they are subject to known and unknown risks and uncertainties; all statements are subject to change without notice. Also, historical performance cannot predict future results. Diversification and asset allocation help you spread risk throughout your portfolio, so investments that do poorly may be balanced by others that do relatively better. Neither diversification nor asset allocation can ensure a profit or protect against a loss. No investment strategy can ensure a profit or prevent a loss. Past performance is not indicative of future results. Investment decisions should be based on your individual goals, time horizon and risk tolerance. Commodities are volatile investments and should form only a small part of a diversified portfolio. An investment in commodities may not be suitable for all investors.