This is the age of investing “uncertainty.” Funny thing though, this has been the case in every decade from the 1920’s to now. Each decade and era has had a multitude of challenges and left investors feeling like they “just wish things were normal.” I’ve been practicing 20 years; I’m still waiting for “normal.”
The only time I remember most investors agreeing that the stock market was both “normal” and “certain” was 1999, just before the bottom fell out of the U.S. stock market. The truth is, there are always challenges in investing that leave us wishing we knew what was ahead so that we could not only be prepared but capitalize on volatile markets. But absent knowing the future, I’ve come to one incontrovertible investing concept, for which I am very thankful during this season for giving thanks: diversification. I thank all the researchers, professors and professionals who taught me about true diversification, the greatest tool in a prudent investor’s toolbox.
It’s all about dissimilar price movements. That’s it, plain and simple. Try to build a portfolio that combines asset classes with the least amount of price commonality. By owning these important asset classes, you can then smooth out volatile markets, at least somewhat, so that in the long run the smoother portfolio with the least amount of volatility wins (average returns being equal). While it’s still imperfect, it’s as good as we can find. It just makes darn good sense, too!
Many times through the decades, however, we’ve been reminded that diversification can be somewhat frustrating. When one asset class is dominant for a period of time and other asset classes lag, we may question its relevance. But lest we think diversification is overrated, almost always there is a reversion to the mean and investors are rewarded for both the patience and the intelligence to remain diversified.
Forget for a moment that diversification has been shown to reduce risk and add value to returns relative to the S&P 500. One of the biggest reasons we diversify is so we don’t have to be preoccupied with the maddening and impossible world of market timing that increases costs and taxes in most cases. I say market timing is impossible, but I suppose it is only impossible for those who aren’t fortune tellers, which includes you and me.
Finally, diversification helps combat the constant onslaught of negative news by easing your mind. While economic news can be an endless source of fascination for some, we hope you’ll appreciate it for what it is: short-term “noise” or “investment pornography” with limited or no lasting long-term effect. Each time forecasts fall short, conflicts erupt overseas, economic malaise is reported in other countries, terrorists attack or any number of negative headlines occur, we witness financial markets moving immediately in order to price-in the new data. This is absolutely normal and actually one of the primary roles of well-functioning markets.
So the question is: Should we as investors allow these “surprises” to dictate our investment strategies? The answer is, unequivocally: No. Ideally, investors should pursue strategies that target the true drivers of investment returns and ignore all things that attempt to distract us from what truly matters. Again, this is where true diversification makes so much sense; we are not relying on one country, one sector or one specific market. Therefore, there is no need or benefit to jump around or be “in or out.”
Obviously we would all love a world full of certainty and absolutes, a world where we always know what asset class to be in or out of, and when to be in or out. Unfortunately, the world has yet to uncover the person or computer program capable of such feats. That leaves us with a great, yet imperfect solution. Diversifying globally and broadly among different styles and keeping investment costs low remains the very best strategy. While the diversified portfolio will never perform as good as the best asset class, it will also never be as low as the lowest-performing asset class.
Craig C. Rogers is president and chief operating officer of Rogers Wealth Group, Inc. For more information, please contact: CRogers@rogerswealthgroup.com