True Story: My next door neighbor a few years ago went to his local Honda dealership and bought 2 Hondas. He got a Honda Minivan and a Honda Accord. Clearly he was looking for dependability. My wife and I went out to dinner with him and his wife in the new Accord. I complemented him on the comfort and the electronic gizmos that populated the dashboard. His response was “Yes, thanks”. Clearly he liked the new car but he did not exude a lot of enthusiasm. A year later I noticed that he had traded in the Accord for a Mazda Miata (sports car). The Miata was a convertible. A few days later, my wife and I were out for a walk, they drove by with the top down, and pulled to the curb so we could chat. I said, “Nice Car! why did you get rid of the Accord?” And, he said, “The minivan and the Accord were too much alike.” Yes they were different body styles, but they were so close in their ride and feel, that they really wanted more variety. The Miata, was strictly a two-seater, a convertible, lower to the ground, and really fit the sporty car image. And besides, he said, “the Honda Minivan has plenty of space, and gives a reliable ride for long drives…we wanted something different.”
The fact that, my neighbor has a two car garage does not necessarily mean that the garage should have the same or similar car in each bay. Could he have opted for reliability and comfort for both cars? Of course! However, there is something about the human psyche that craves variety. Variety is almost hardwired into our makeup. But we do not like change for change-sake. Witness the daily routines that we all follow…we are literally “creatures of habit”. Interestingly, the process of defining habit is based on analyzing all the diversity that confronts us on a daily basis. “Should we do this, or should we do that?” “Should we buy this, or should we buy that?” One of the great capacities of human beings: being able to compare and contrast between different options. The capacity for comparison is so great that we spend an enormous amount of time actually thinking about it.
OK, so what does this have to do with investing? Think of the garage as your portfolio. If it has two bays or even 3 bays, it obviously has room for more than one type of investment strategy. Notice the emphasis on the phrase investment strategy! Wall Street has spent so much time talking about diversification that this area can be confusing. A strategy usually embraces two distinctly different areas: performance management and risk management. One strategy should perform differently from another strategy in different types of markets. Remember my neighbor? Just recently I was talking to him, and I brought up the topic of his Mazda Miata. “Still like it” I asked? He said, “You know something, the Miata is great for short drives, but when we go out to see our daughter (long drive) we take the minivan.”
The reason to have more than one strategy in your portfolio garage is very apparent: it will give you two different types of performance. But, what is not so apparent is that it engages our natural tendency to compare and contrast. The act of comparison is also an incredible educator. You could derive the following conclusion: this type strategy does better in this type of market than another type of strategy. That conclusion is incredibly valuable to a private investor.