Generally speaking no one wants to think of themselves as average, but when it comes to investing being average can be your friend. What do I mean by this? Everyone would like their investments to outperform the hottest sector. By striving for this, you will inherently take on more risk which can be quite damaging to you during retirement. I believe in diversification*, which means spreading a client’s assets over many asset classes in order to potentially reduce risk. I am in the loss prevention business, so I am trying to hit singles and doubles for my clients, not home runs. Swinging for the fences means I would probably strike out a lot. This is not acceptable for most of my clients who are in the later stages of the game. They have already won. They just need to preserve what they have and stay out of harm’s way.
Many financial markets are in bear territory now. International, emerging markets and commodities are all down. By definition a well-diversified portfolio will contain all of these asset classes, so will never outperform the best asset class of the year, which over the last two years happens to be large company U.S. stocks. If you look at the stock market performance of a diversified portfolio over the last 44 years, it has averaged the same return as the S&P 500. However, many times it significantly lagged the S&P.
For example, look at 2013, the S&P 500 was up over 32% while a diversified portfolio was up only 13%. This trend continued into 2014. How could the diversified portfolio perform the same as the S&P over the long run, but lag so much in the short run. The answer has to do with the down years. Down years are much more damaging to one’s financial health than up years are beneficial. For example, a 40% loss in value requires a 67% gain to get back your money. In retirement, most people cannot afford to take this type of risk. However, human nature being what it is, people are tempted to want to overweight U.S. stocks and sell the poor performers such as international, emerging markets and commodities.
My suggestion: You fight the urge, think long-term and take advantage of the deals. Buy assets that are down and trim assets that are expensive, currently large company U.S stocks. This strategy is emotionally difficult to implement, but has proven itself over time. Assets have a tendency to revert to the mean.
*Diversification does not assure a profit or protect against loss in declining markets, and diversification cannot guarantee that any objective or goal will be achieved.
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