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Fundamentals: Diversification - "Avoid the Guessing Game"

          Diversification is key. You might say “Yeah, I know. Don’t put all your eggs in one basket…We get it.” But some have a tendency to throw diversification out the window with the US stock market hitting record highs. The S&P 500 has brought investors a monstrous 39% return since January 2013. Last year recorded the largest S&P annual return since 1997 (29.6%). One of the best we have seen in the last forty years!

 

         Why don’t we sell the underperforming emerging market funds? Or get rid of bonds that are yielding historically low rates?  Because we need them…This is a common trap investors fall into. Everyone wants to be in the asset class that is going up. I don’t blame you. We are human. Yet, the idea to overweight into one asset class and abandon others is flawed thinking.  Taking that course of action would put your financial plan at unnecessary risk.

 

          Frequently in the investment world, you read in magazines or financial statements the phrase “Past performance is no guarantee of future results.” This is exactly right. No one knows if stocks will go up or down in the coming year. Or more specifically, what category of stocks will go further up or down. Investment returns are RANDOM.  We never know what asset class will be at the top of the performance chart each month, quarter, or year. It’s a guessing game. See for yourself…

 

          Returns are completely random in the short term.

          There is no reason to attempt to time the market or rely on our emotions to determine portfolio allocation. While it may seem counterintuitive, selling underperforming “loser” funds is no better than trying to find the next “winner” fund. We believe trying to decipher “winners” and “losers” is a pointless exercise.  Instead, we endorse using evidence-based (passive) mutual funds that represent different sections of the market and overall performance is simply the collective total return of the markets that we invest into.

           It is important to realize that a diversified portfolio will ALWAYS lose compared to the “winner” of the year. Yet, a diversified portfolio will ALWAYS beat the worst asset class or “loser” of the year. In the next part of this series, we will examine the historical results of a classic diversified portfolio.

          Stick with diversification. Stay on your asset allocation. Avoid the guessing game.

 

 

Written by Roddy Warren

Issued September 24, 2014

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