Casey Snyder and Tom Sedoric
After a five year bull market in U.S. equities, many investors may be questioning the purpose of owning anything other than a U.S. index fund – I understand, I’m human too. Anyone who hasn’t questioned the proposed benefits of global diversification likely has ‘Bill Belichick syndrome’ – i.e. the rare ability to emotionally disconnect.
I could certainly provide a great deal of statistical data in support of these benefits, but for most, historical data doesn’t quite hit home thanks to the powerful influence of the present. Rather, I want to share with you why diversification matters to me, based on my experience observing how a lack of diversification has significantly impacted people’s lives. After all, the people we love and the goals we set are often why we’re investors to begin with.
The NASDAQ recently broke 5,000, a level it hasn’t reached in fifteen years since the peak of the tech bubble in 2000. When adjusted for inflation, however, it still has quite a way to go before becoming whole. In 2000, many 40-something year old, undiversified investors had their life’s plans change dramatically following the correction. To make up for it, it may be necessary for them to save up to 30% of their annual income just to reach their goals (that’s a lot!), instead of a more comfortable 15%, due to the many years they fell behind during the technology sector correction. In addition, the expected excess income and bonus money like that of the early 90’s never quite materialized into what was envisioned. As a result, many of their children’s educational expenses have required sizable loans, rather than having been paid in cash. Thus, the influence of an event 15 years ago lives on by means of debt accumulation within the current and next generations and will likely live on much longer as repayment continues.
Not long after, the housing craze of the mid 2000’s left millions of home owners under water. Unwavering optimism was the theme, and futures were crafted as though the present would continue indefinitely with only minor bumps along the way. Rational, well-educated people with pure intents for their families were severely impacted by the downturn, as they witnessed their futures become significantly altered from what they once envisioned.
All of a sudden, cashing in on the equity of one’s home to account for future expenses ceased being a viable option. Here again, lifestyles changed dramatically following a recession and crisis very few ‘experts’ saw coming.
My point is this: there are many examples throughout history similar to those of the boom and bust of the tech and housing sectors. And, despite the discomfort often associated with recessions; they are a common, frequent, and, I believe, necessary component of our economic cycle.
As savers and investors today, we’re faced with one of the most uncertain environments markets have ever witnessed. The truth is, unless we have a crystal ball, there is no way of knowing what the future holds. Maybe volatility and risks remain contained forever, or maybe they don’t, and the next correction is right around the corner. Without knowing the future, it’s important we don’t deceive ourselves into believing we have the ability to predict the best market or asset class - despite what many media outlets will tell you.
I wrote this update to serve as a reminder to all: diversification isn’t designed to keep up with a benchmark or maximize returns every year. It’s a tool to help people reach their goals by reducing the volatility and risks associated with events such as those I have outlined above. It’s also used to capture value within out of favor asset classes by inherently offering cheaper entry points, in order to enhance returns over time. Most importantly, it serves as a hedge for our inability to predict the future. Everyone’s heard the mantra: “Buy low, Sell high”. Seems easy enough, right? Unfortunately, as humans with emotions, we are far more likely to “Buy high, Sell low”. These are just a few of the many benefits, but certainly highlight why I believe proper diversification and staying the course is so critical to future success.
And of course, per the regulatory powers that be, I can’t end such rhetoric without the required disclosure. “Asset allocation and diversification cannot eliminate the risk of fluctuating prices and uncertain returns, nor can they guarantee profit or protect against loss in declining markets.”
For more on this topic, please see the following article from the NY Times which is also posted to our reading list: Diversification: The Sane Alternative
Obviously, I welcome any questions you may have, and acknowledge the concept of diversification is often far easier than the follow through.
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