Financial markets give every single one of us plenty of opportunities to be “wrong.” Wrong in the sense that we transform things that we believe are highly probable into a forecast for what will definitely occur. The difference is subtle, but the nuance between likely and certain is crucial for investing. Recognizing that difference protects portfolios from overconfidence. As complex and theoretical as this mental framework can be, one of the best solutions hides in plain sight in the form of timeless wisdom. Stay diversified in your investments.
The Chief Investment Officer of the Financial Enhancement Group, Adam Harter, CFA, says, “The number one strategy for your portfolio is understanding and deploying proper diversification. It is the only free lunch in investing.” He continues, “The only way to sleep at night when you are responsible for more than $600 million is to know the rules and follow the discipline.”
Investors faced ample opportunities to be “wrong” or opportunities to “know” what would likely occur in 2020. Individuals and institutions faced significant investment challenges as prognostications and emotions of doom and gloom overrode financial disciplines. Discipline doesn’t just apply to having stayed invested through the March lows. It also means having had the restraint in February not to be overly aggressive ahead of the coming swift reversal. Remaining calm in the wake of massive market moves sounds much more manageable in retrospect than it did with a market that was consistently trending higher at the time. Discipline on both ends paid huge dividends that will impact nest-eggs for years to come.
Boundaries lead to natural diversification. If you limit your bonds, you’ll own some stocks. If you restrict your stock ownership, you’ll own some bonds. Diversification doesn’t mean you have to buy baskets of everything to check all the asset class boxes. But we firmly believe that investors must own enough (truly different) things to protect you from the times in which the cards go against you. It protects you from being overexposed to or overly influenced by any one factor.
Published and average returns in markets overstate the results of the real world. Numerous studies show the investing public rarely experiences average returns. Emotional responses lead to rotating investments at the wrong times and wind up not achieving the stated average returns. The phenomenon does not just apply to retail investors; it applies to professionals as well. We are all human, and we all share imperfect decision-making processes. We flock to winning strategies and flee losing ones far too late, on average. Proper diversification will never be the top performer on investing charts, but it won’t be at the bottom either. Diversification fights against our natural human instincts to change course at the wrong time. Sticking with these middle-of-the-road, but reasonably consistent returns are what will allow you to float to the top over time.
The investment world is full of choices, and people love options. Decisions are tough. Discipline can be aggravating, but it can also protect your financial future.
Joseph A. Clark is a Certified Financial Planner and Managing Partner of The Financial Enhancement Group, and an SEC Registered Investment Advisor. Contact Joe at yourlifeafterwork.com or 800-928-4001. This article was co-authored with Adam Harter, CFA. Securities offered through World Equity Group, Inc. Member FINRA/SIPC. Advisory services can be provided by the Financial Enhancement Group (FEG) or World Equity Group. FEG and World Equity Group are separately owned and operated.