Can we learn from our mistakes?
We all have regrets. Why didn’t I finish my degree? We should have gone camping last summer. Why did I send that email? “If only” thinking plays a big role in our lives. In general, our emotions send us helpful messages. Ignoring them can mean we persist in counterproductive behaviors and we miss opportunities to improve ourselves.
But not always. When it comes to investing, “if only” thinking can lead you to chase the latest hot stock or asset class. In our portfolios, if we measure our success by comparing all of our investments to the top performers, then we’re doomed to be unhappy.
When we look at stock and bond returns over the past decade, US stocks have returned about 7.5% per year, while US bonds and international equities have returned about 4.5%. Does that mean it was a mistake to include bonds and global stocks in a portfolio? Not necessarily. During the financial crisis, bonds were an island of stability in a period of global tumult. And just because non-US equities have lagged the US lately doesn’t mean that will continue to do so. By many valuation measures, global stocks are significantly cheaper than their domestic cousins.
If every sector in your portfolio is doing really well, you’re either really lucky or too concentrated. Diversification is the complement that humility pays to uncertainty. We don’t know the future, so we spread our bets across as many different asset classes, industries, sectors, and countries as is reasonable. Being truly diversified means that there will always be a part of a portfolio that looks awful.
The math of diversification makes sense, providing the best risk-adjusted returns over time. The psychology of diversification can be challenging, though, especially when we’re tempted to think, “If only I had put all my money into Apple or Amazon 10 years ago. It would have grown over 10-times!”
But this decade’s Apple could turn into the next decade’s oil patch. Sure things are never sure, and what seems obvious in retrospect isn’t clear ahead of time. It’s good to learn from our mistakes, but only if we take away the right lessons. Jumping on the latest fad is a pretty predictable way to under-perform. But we also need to acknowledge that while diversification is good for our portfolio’s health, it’s a medicine that tastes bitter at times.
Douglas R. Tengdin, CFA
Chief Investment Officer