Advertisement
investing

Why You May Not Be Beating the Market Right Now

Even if it's not matching the S&P 500's recent heady returns, a well-diversified portfolio is still your best bet in the long run.

That the stock market hit new highs in July, less than six months following one of the worst market declines in a while, was surprising to most investors. The market shook off the Brexit vote like it was just an annoying fly, and it continues to charge through discouraging economic news and increasing global strife as if they didn't matter. So, it was inevitable that we began hearing from some clients wondering why their portfolios are underperforming Standard & Poor's 500-stock index, which is up more than 18% from its February low, as of July 27.

The inconvenient truth is that diversification is the reason behind their underperformance. It's inconvenient because these are the same clients to whom we have been incessantly preaching the virtues of diversification as the absolute key to positive long-term returns. It is times like these, however, when diversification is bound to disappoint.

Why Diversification Has to Disappoint Sometimes

The challenge for diversified, all-stock portfolios is this recent stock market surge has been narrowly concentrated in domestic, blue chip stocks, as it has been with the stock market rally of the last few years. So, if your portfolio is diversified among several different stock asset classes (i.e., small cap, international, emerging market, etc.), it is not likely going to achieve S&P 500-like performance. In fact, with an optimally diversified portfolio, you are likely to be disappointed with at least a third to as much as half of your portfolio at any particular time.

Advertisement - Article continues below
Advertisement
Advertisement - Article continues below

It is also times like these, however, when you need to step back and take a long view of the stock market to remind yourself what diversification has helped you achieve in the past and what it is expected to achieve in the future. It is easy to view the market in hindsight and second-guess your strategy; it's not so easy to see and plan for what lies ahead. Diversification is recognition of that uncertainty, and it liberates us from the pressure of having to always be right. Diversification allows us to be vaguely right all of the time, while never being completely wrong. When considered in the long view, and with so much at stake, that's a winning proposition.

You Can't Invest With Hindsight

Consider the performances of S&P 500 stocks and emerging-markets stocks over the past decade. Investors with a diversified stock portfolio may complain that four out of the last five years, emerging market stocks, as measured by the MSCI Emerging Markets index, were a serious drag on S&P 500 stocks. During that period, the MSCI index averaged a negative 4% return, while the S&P 500 averaged about 13%. However, between 2004 and 2010, S&P 500 stocks, which averaged about 6%, were an even bigger drag on emerging-markets stocks, which averaged 25%.

Advertisement - Article continues below

The reality is a diversified portfolio captured the outperformance of both markets in their best years, while smoothing out the risk and volatility of both markets in their worst years. The purpose of a broadly diversified portfolio is to capture the returns of all of the sectors over time but with less volatility at any one time. It is also important to note that, over time, passively managed portfolios of stocks have outperformed actively managed portfolios that rely on market timing and individual stock selection.

Diversification Means Never Having to Say You're Sorry

The incessant noise and information overload we experience every day, which, by the way, can only impact short-term outcomes, does more to distort our reality of the long-view than provide us with any sort of advantage. When applied with discipline and patience, a thoughtfully conceived diversification strategy enables investors to ignore the noise and focus instead on their long-term objectives, which aren't impacted by what the stock market does in the first six months of the year.

Advertisement - Article continues below

By taking a step back to view your portfolio as a whole, and not by its parts, you get a much clearer investment perspective and a reminder of some of the fundamental truths of investing:

  • the markets are random—it's impossible to time the market with any degree of consistency;
  • risk and returns are related—adding higher-risk elements to your portfolio improves long-term performance, but they are mitigated through diversification;
  • and over the long term, a diversified portfolio will yield higher returns while minimizing the risk of any single investment or market segment.

As an investor you need to ask yourself: Would you rather be mildly disappointed that a portion of your portfolio underperformed another, or massively disappointed that you guessed completely wrong by investing in a single market segment at the wrong time?

Craig Slayen is a principal at Cypress Partners., a financial planning and investment management firm in the San Francisco Bay Area.

Pete Woodring, a partner with Cypress Partners, contributed to this article.

Advertisement

About the Author

Craig Slayen

Principal, Cypress Partners

Craig Slayen is a principal at Cypress Partners., a financial planning and investment management firm in the San Francisco Bay Area.

The firm believes that the key determinant to long term financial success is based around three concepts: sound planning, prudent investing, and an awareness of the behavioral traps that can kill portfolio returns.

Craig is the author of Successful Investing for Female CEO's, published by Charles Pinot. He is a graduate of UC Berkeley.

Advertisement

Most Popular

11 Dividend-Paying Stocks You Should Think Twice About
dividend stocks

11 Dividend-Paying Stocks You Should Think Twice About

Dividend-paying stocks often can be a store of safety, but 2020 has been difficult on income equities. These 11 picks look like shaky plays despite th…
September 21, 2020
Medicare Basics: 11 Things You Need to Know
Medicare

Medicare Basics: 11 Things You Need to Know

There's Medicare Part A, Part B, Part D, medigap plans, Medicare Advantage plans and so on. We sort out the confusion about signing up for Medicare --…
September 16, 2020
Where You Should Invest Now
investing

Where You Should Invest Now

Kiplinger.com senior investing editor Kyle Woodley joins our Your Money's Worth podcast to answer investor questions about tech stocks, the election a…
September 22, 2020

Recommended

Bonds: 10 Things You Need to Know
Investing for Income

Bonds: 10 Things You Need to Know

Bonds can be more complex than stocks, but it's not hard to become a knowledgeable fixed-income investor.
July 22, 2020
Best Bond Funds for Every Need
Investing for Income

Best Bond Funds for Every Need

In a changing market, it’s important to remember why we hold bonds in the first place.
September 15, 2020
Does a 40% Bond Allocation Make Sense in Today’s Portfolios?
retirement planning

Does a 40% Bond Allocation Make Sense in Today’s Portfolios?

For many investors, the short answer is no. Here’s why, and what you might consider instead.
September 7, 2020
Is the Stock Market Closed on Labor Day?
Markets

Is the Stock Market Closed on Labor Day?

The good news: Stock markets and bond markets alike get the day off for Labor Day. But traders don't get an early start to the weekend.
September 5, 2020