The Risk-Return Trade Off
If you invest and don't diversify,
you're literally throwing out money.
People don't realise that diversification
is beneficial even if it reduces your return
Over the past 10 years or so, investors managed to get away with poor investing habits. Whatever they threw their money at seemed to work out pretty well. Investors who chased bonds year after year made good money from capital gains as yields continued to fall towards zero. We know the theory — you’re not supposed to put all your money into a single country, instead, investing in various regions around the world was the smart thing to do. But in the past decade, if you had a hefty position in US stocks, you would be smiling as they have completely outperformed without competition. Love the tech sector? Getting into any mega-cap technology name would have paid off handsomely. What about the latest day-trading and speculation fad - the meme stock craze such as Gamestop and AMC? No problem, with at least 100% gains!
However, it may appear that the tide may finally be turning. Bond yields have risen significantly over the past two months, presenting investors with the prospect of capital losses on their safe investments if this continues. Technology has had a bad start to 2021, but the underperformance started from Oct 2020. Even laggards - stocks and sectors which investors had shunned for so long like Energy and Financials have begun to rise up “from the grave”. The charts below show the difference in performance between the various sectors over the past 3 months.
Not too long ago, financial strategists and publications have been touting the “death of value stocks” citing changes in market structure, economy and how assets are valued these days. This type of thinking pops up ever so often prompting John Templeton to famously quote “the four most dangerous words in investing are this time it’s different.” However, value stocks have been having an excellent six months and could be on course to have a great year.
Of course we really do not know whether this will come true or is just a temporary thing. In the same way that we really don’t know whether technology will continue its insipid performance and whether the energy sector could be the next big thing. There are numerous logical arguments for and against each theory.
This is why we are paid a return to take risks in investing. There are no clear signals when it comes to putting your money to work in capital markets. There was no indication that tech would start to do poorly and the laggards suddenly would spring to life. This is just how investing works.
Chasing the good performers is often a stressful task. Do you sell your technology stocks now given that they have had a couple of bad months? Has Energy and Financials run too far ahead? What would be a good price to get in? What about other value sectors - should you go in now? What type of returns or losses should you be expecting? Going through such an exercise is akin to changing lanes when you are stuck in a traffic jam. You spot a lane that is seemingly less congested, and after some effort and angst to switch to it, you suddenly realise the cars in your original lane has moved on ahead of you.
So has the market changed and is this time really different? No one really knows and anyone who says they do hasn’t spent enough time studying market history or human nature.
Spreading your money across a wide range of investments, asset classes, and geographies is the humble acceptance of the fact that we simply have no idea what’s going to happen in the future. Yes, returns are reduced, but more so from a risk perspective to the point that ensures your money stays intact throughout cycles so you can proceed with your investment journey relatively stress-free.
