January 20, 2015

You Might Be Well Diversified If...

You are probably familiar with comedian Jeff Foxworthy’s “You Might Be a Redneck” routine. If you’re not, you should be! His routine is hilarious, and since I was born and raised in the Southeast, I've seen some of what he is talking about. I’ve seen driveways where it doesn’t look like the boat has left the driveway in 15 years. I’ve seen people whose dog and wallet were both on a chain. I’ve seen yards where if someone mowed them, I believe they might just find a car! It’s funnier when he does it, but you get the point. Either way, it got me thinking about an idea for today’s post…

By now you’ve probably gotten the year-end statements for most of your investment accounts, and if you’ve looked at them closely, you might have noticed 2014 was kind of a weird year for stocks. I say it was a weird year for stocks because some of the classes of stocks had very different returns. U.S. stocks ended up having a pretty good year after some ups and downs, but international stocks finished the year down for the most part. If you took a closer look at U.S. stocks, you likely found that the stocks of large U.S. companies (“large cap stocks”) did pretty well, but the stocks of smaller U.S. companies (“small cap stocks”) were not up nearly as much as their larger counterparts. Small cap stocks were even negative for a good portion of the year!

Statistically speaking, the S&P 500 (an index that represents large cap stocks) was up between 13% and 14% for 2014. The Russell 2000 (an index that represents small cap stocks) was up around 5% for 2014. The MSCI EAFE (an index that represents international stocks) was down around 5% for 2014. Why do I tell you all of this? To share with you that, if you had a stock portfolio filled with large cap stocks, small cap stocks, and international stocks, you probably didn’t end up with the 13% to 14% return “the market” had in 2014 that the television pundits, radio hosts, and investment newsletter writers keep talking about! As Jeff Foxworthy might say, you might be well diversified if you did not end up with the S&P 500’s return!

I’ve also heard it said that you know you are well diversified if there is always part of your portfolio that you are “mad” at. I’m not sure that’s always the case, but there is definitely some merit to that statement. If you were mad at your bonds in 2013 when the stock market roared, I bet you were pretty pleased with them in 2008 and 2009 when the stock market took a dive. If you were mad at your stocks in 2008 and 2009, I bet you have been pretty pleased with them the last five years or so. So all in all, you might just be well diversified if there’s usually a part of your portfolio that you aren’t pleased with.

If what I’ve said so far hasn’t really applied to you because you only own one stock or a couple of stocks, I’d offer two things. First, concentration in a single stock is how you can accumulate and/or evaporate wealth - not preserve wealth. Second, you might be well diversified if you can’t name every holding in your portfolio from memory!

As your friend and someone who wants you to do well and make as much money as you can, I wish you were completely invested in the S&P 500 last year and got that 13% to 14%. However (and please read my next words very carefully), as your humble financial blogger and a financial advisor who believes in the long-term investment strategies of diversification and compounding, I certainly hope you didn’t!


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