5 Thoughts On Diversification

September 22, 2015

5. Your Gut Is Mostly Wrong

Investing can be counterintuitive. Investors tend to try and use information they have received in other areas of their life and apply those principles to investing. Oftentimes, sayings such as “my Daddy always said” or “I heard about this at the gym” or “I have a feeling that” can lead to actual financial decisions.

One main principle that is counterintuitive is the ongoing nature of the stock markets. While we arbitrarily assign measurement periods, such as month-to-date or year-to-date or five-years trailing, the stock market doesn’t really care what the calendar says. Fortunes can be made or wiped out in unfair time periods, and January results don’t care that you were a top performer at the end of December.

For example, let’s apply this principle to education. A college degree is an accomplishment. I remember looking at my first diploma and saying, “No one can ever take this away from me.” I worked hard and accomplished it.

What if your alma mater set up a system where they could send you random texts anytime between 9:30 a.m. and 4 p.m. on a weekday, and if you didn’t respond within 15 seconds with the correct answer, you had to surrender your degree?

What if the classes never really ended, and your grades in Sociology 101 were adjusted all day by how you interacted with others, and if your lifelong grade dropped low enough that you had to start the class over again?

Sounds crazy, right? That’s because investors are people, and people are used to a winner and a loser over a defined time period. At some point in nearly every sport, the buzzer goes off, and a winner and loser are declared.

What defines a winner in investing? We all know that most actively managed mutual funds fail to outperform their benchmark over time (see S&P Index Versus Active Reports). Likewise, we know through research that most star managers eventually regress to the mean. Does that mean there are no winners?

We believe the winners are the investors who properly diversify and receive appropriate risk-adjusted returns over time.

What Should Investors Do?

Serious investors should invest primarily in a disciplined, globally diversified portfolio over time.

Like guidance to eat a balanced diet, we recognize it is difficult to stick to a plan. The dessert menu (speculation), candy bar aisle (market timing) and fast-food line (lure of potential outperformance) will continue to be distractions.

However, a globally diversified portfolio over time provides investors with the highest likelihood of appropriate risk-adjusted returns, not to mention that many diversifiers are currently trading at historically attractive prices.

ValMark Advisers Inc. is the manager of the TOPS Portfolios of ETFs. ValMark started managing "TOPS" separately managed accounts of ETFs in 2002. The firm manages more than $5.1 billion in ETFs for retail and institutional clients in multiple investment products. Email:[email protected]; phone: 800-765-5201. For a complete list of relevant disclosures, please click here.

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