2-minute read
I have an apology to make.
What now?
It’s about your portfolio.
Go on…
You know how I preach diversification? How I’m a believer in investing your stocks in a mix of asset classes? Well…
Well what?
It’s not working right now.
What do you mean exactly? Are you blowing me up?
No, no, no. Far from it. But sizable gains are being left on the table.
How sizable is sizable…?
Check this out[1]:
Please elaborate. I prefer not to interpret my own hardship.
There are several asset classes to invest in but the four in the chart – large cap growth, large cap value, small cap, international – represent major areas of the market. A diversified investor often has their eggs in these baskets.
Why these baskets?
Because their financial advisor told them to.
Is it really the best time for snark? I preferred the apologetic tone to be honest.
We have spoken in the past about how the S&P 500 is being driven by a small number of stocks – an NBA superteam of sorts. In 2023 it’s as if these few stocks are driving a diversified investor’s entire portfolio, not just the S&P.
Can’t we just own those stocks? Or heavily tilt the portfolio towards them?
Investing your entire portfolio in 10 stocks presents heavy concentration risk. You can more heavily tilt the portfolio towards them, but even that can backfire.
Well it hasn’t really backfired in the past 10 years or so. Those big stocks have ruled the market.
You are correct. But are you sure that continues?
For the foreseeable future it seems like a safe bet.
Take a look at this[2]:
Jog my memory on large cap versus small cap stocks…
Cap is short for “Capitalization” which is a finance term for market value. The large cap stocks are bigger, generally more well-known companies. This is where these stocks live that have recently ruled the market. Small cap stocks tend to be lesser-known companies but still are traded on the public markets.
Understood.
Let’s put aside international stocks for a minute and refocus on the chart. As you can see, large cap stocks have seen lower returns in 5 of the past 9 decades.
So why are small caps getting their lunch handed to them right now?
Certain factors are at play – rising interest rates, unfavorable economic backdrop – but it is hard to pinpoint the exact reason for the crummy performance.
It sure is crummy.
Well, here’s the good news[3]:
A cute quilt?
The chart maps out most of the major asset classes that investors typically own. Each color is its own asset class listed by annual returns. The squares on the top row had the best returns that year all the way down.
What’s the deal with the big yellow box in the middle?
I wanted to highlight the white boxes. These are an equally weighted mix of the other asset classes. Consider this a diversified portfolio.
Seems to hang around the middle of the pack.
Exactly! It sucks to leave gains on the table, I get it. But owning a mix of winners and losers is not quite bad. You avoid the pitfalls of market timing which will benefit your investments and your mental wellbeing.
That’s quite an infomercial on mediocrity.
It has been said that diversification is a recipe for average returns. And average returns compounded over time get you to where you want to be. 2023 may be playing a different tune, but I will march to the beat of diversification’s drum any day.
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[1] Source: Russell US Indexes and MSCI. YTD through November 24, 2023.
[2] Source: https://rpc.cfainstitute.org/en/research-foundation/sbbi
[3] Source: Baird’s Q3 2023 Rolling Returns report