SMART MONEY: It’s Good to Hate Part of Your Investment Portfolio
By Brad Brain
Do you hate part of your investment portfolio? Good! That might mean that you are doing things correctly.
If your entire portfolio is moving in the same direction that’s actually a sign of a potential problem. Sure, it will feel great if everything you own is going up all at once, but if everything is going up all at once, that probably means that you are vulnerable to everything coming down all at once. The objective of diversification is to try to avoid the risk of all your investments failing simultaneously.
Diversification is a fundamental investment principle, but its also one that many people get wrong. Diversification does not mean holding 3 or 4 different Canadian Equity mutual funds, nor having your RRSP at more than one financial institution. These are common examples of what some people will naively do in the pursuit of “not having all my eggs in one basket,” but neither means you are diversified.
Having multiple mutual funds with the same mandate is not diversification, its buying more of what you already have. Having RRSPs at different institutions is not diversification, its compartmentalizing your investments instead of incorporating them into a holistic financial plan.
What diversification really means is buying high quality investments that can stand on their own merits, but also work as part of the bigger picture to help you achieve your financial goals.
One of the biggest enemies of diversification is chasing past performance. It’s very common for people to pile into last year’s winner, expecting that past success will repeat. Chasing past performance will not help you build a diversified portfolio. And, even worse, its probably setting you up for disappointment.
Every year, some type of investment comes out on top. But it is rarely the same asset class two years in a row. Here is what I mean.
In 2007 Emerging Markets were the best-performing asset class, up 39.8%. This would have made a lot of people want to run out and buy some Emerging Market mutual funds. The problem is that over the next year they lost 53%.
Equities outperform bonds over the long term. But in the Great Recession of 2008 pretty much every category of equity you could think of tanked, and U.S. bonds were the top asset class, making 5.2% in an ocean of red.
Coming out of the pandemic, U.S. large-cap tech stocks dominated. But in 2022, tech-heavy NASDAQ fell nearly 33%.
The message is that loading up on whatever was hot the year before often means you buy into something just in time for it to lose favour. Some studies have shown you have a far better chance of success by buying last year’s worst performing investment than you would with buying last year’s superstar.
Picking the next winning investment is really hard but, before you lose hope, the good news is that picking next year’s winner isn’t really necessary.
The strategy for success is, don’t think like a gambler. Think like a gardener.
Instead of trying to predict the future, consider simply holding a properly diversified portfolio across different asset classes. Sure, you won’t have heavy exposure to whatever is hot at the moment, but you also will not be over-exposed to the worst performer either. Don’t try to make a killing, and you won’t get killed.
Real diversification isn’t exciting. But it’s a great way to build wealth over time. In any given year, some of these will shine. Others will lag. And that’s okay. Your goal isn’t to win every race every year. It’s to stay invested, control risk, and grow steadily. Slow and steady wins the race.
This is why I say that its good if you hate part of your portfolio. Maybe you hate your U.S. equities now, but your bonds are looking good. Maybe next year your bonds are lagging, but your international equities are doing well. Maybe after that your international equites are quiet, but energy stocks are back in the spotlight.
This is what real diversification looks like. This is what it means to not have all your eggs in one basket. This is how you survive bear markets.
Brad Brain. CFP, R.F.P., CIM, TEP is a Certified Financial Planner in Fort St John, BC. This material is prepared for general circulation and may not reflect your individual financial circumstances. Brad can be reached at www.bradbrainfinancial.com.