Waves, Harmonics, and Investments

I learned something interesting the other day -- there's a similarity in the way waves, sounds, and investments work.

When waves meet in the ocean, they either build on each other or they offset each other, as shown in the diagram below.

Sounds work the same way, but with human voices and other complex sounds there's a big wave (fundamental) flavored with small waves (overtones). Kind of like this, but with a lot more small waves:


Investments work the same way. Since investment returns generally look like waves (hopefully with more ups than downs), individual investments can be used to offset each other. If they're perfectly opposite, like the two below, that's perfect -- you can invest in those two funds and have a constant 15 percent return.


Now, unfortunately, no such perfect matches exist, yet the same effect can be gained by combining the "waves" of about 25 to 30 investments, even if they aren't complete opposites.

When combined in a portfolio, the variances from the average return (what fund managers call "specific investment risk") offset each other like the countless waves in the ocean, and the investor is left with a portfolio whose returns vary little from how the the market is doing in general.

How about that. I would have never thought they were related....