You’d think beachgoers would be pretty happy right now. “Honey, would you reach into the beach bag and hand me our retirement account report.” (I know this is an absurd example… why would anyone risk getting sand or Coppertone on their statement?). The S&P 500 is up a little over 12% year to date through June. But I’ll bet most investors are less than 12% richer. Don’t fret. Diversification matters.
How many people have 100% of their retirement invested in the S&P? I think few. Most also own bonds, foreign stocks, real estate, target date funds, or others. And if they had shares in Apple or gold, they’re likely turning red without even setting foot under the hot sun. Prudent investors diversify their portfolios, from managers of the largest endowment funds to Main Street.
Why diversify? Roller coaster rides are thrilling. They’re fun at the amusement park, but best avoided with retirement accounts. Diversification means not having everything in your portfolio going up (or down) at the same time. Most investors prefer a smooth ride.
A better question. We’re constantly comparing ourselves to others – toys, smart kids, and other witty bumper stickers. Investing is no different. Why do we lag the current US stock market (or whatever the hot asset du jour) is one question. Do we have the best diversification is the better question.
Map an imaginary picture. You’re presently at Point A (lower left corner of your map) and you want to accumulate sufficient wealth to retire at Point B (upper right corner). Say you have two different investment strategies to get to B. One is a zigzag, up and down route. The other is a straight line. Which do you prefer? Of course, the second strategy.
That straighter line represents the best diversification issue you should be exploring. Do your homework and discuss with your advisors. Recognize there are multiple solutions. Deliberate for those which make sense and feel right for you, and put the plan in action.
Return to your map. You’ve chosen the straighter line strategy. Note that there are points in time where the wealth from the other strategy are higher. Will you switch horses, or will you have the discipline to stick with your strategy?
When change the investment strategy? What if your straight line strategy unexpectedly starts to zag? The unexpected happens – politics, economies, war, black swans, etc. – or just bad performance. Not that long ago we were worried about fiscal cliffs, a dysfunctional government, and Mayan calendar. Only a demented crystal ball would have predicted that gold and Apple would plummet by about a third, highly leveraged Japan would see its stock market advance 16%, or the S&P would hit 1,680 in May.
Wealth management is rich with opinions and approaches. Our approach focuses on asset allocation (how to “slice the pie”) and investment selection – e.g. allocate 20% to US equities, and utilize managers A, B and C. Both require on-going monitoring and analysis, using risk and return metrics. The challenges are often waiting too long (or pulling the trigger too soon) for strategies to work or managers to perform. Strategy and roster changes (firing a manager) are best done with a disciplined process (vs knee jerk reaction).
Diversification helps investors stay on track with their financial goals, and weather changing conditions. Often, slow and steady wins the race. However, smart investors will scrutinize their investment strategies, and avoid bad investor behavior. Stay financially fit this summer.