diversification

Being Different Isn’t Easy

It’s a rainy afternoon on a Saturday, so I thought it would be a good opportunity to explain something that has certainly come to light in the past few weeks.

Sometimes it’s not easy being different.  2014 is proving to be a great example of that.

As of 10/3, the S&P 500 Index (a fairly good indicator of large US stock performance) is up a hair over 8%.  For the vast majority of the investing American public, they are experiencing a decent positive return on their fund’s this year, simply because of the fact their portfolios very much track this index.  Retail US investors own mostly Large US Company Stocks.  This is not a prudent or diversified strategy.  However, as blind luck would have it, this area of the global stock market is doing comparatively better than many others in 2014.

Take the Russell 2000 (a small cap stock index) for example.  That is down about 8% this year.  International stocks are also on the whole down a small percentage year to date.  That being the case, an investor that holds a diversified portfolio may feel some unease when comparing their portfolio to their neighbors’, or to the popular stock indexes quoted daily on the news.  Their stock portfolio has likely declined this year.

But this is kind of year when disciplined and educated investors earn their increased returns.  “Average” investors, those that hold undiversified portfolios, make poor choices, and invest like 98% of other investors, earn about 3-4% a year over time according to Dalbar’s yearly study of investor behavior.  It may be tempting to chase large cap stocks this year, but do you remember the “dead decade”?  The 2000s were horrible for large company stocks.  The truth is that every market segment will have its day in the sun- and its long stretches of underperformance.  Every year it’s a new winner- and that winner is not knowable in advance.

But you might think, “Doesn’t spreading myself out reduce my returns?  After all, if all my winners are always wiped out by losers, I will never get ahead”.  Well, that would be the case if the long term direction on all of the global stock markets were flat, or down, but it is our view that the long term direction on all developed stock markets is UP.  Some may go up more one year, and in some years some go up and some go down (like this year).  But by being more diversified, and owning more areas of the market, we tend to smooth out the long term volatility, versus placing all of our eggs in one proverbial basket.