An analogy for investment management
Where what you own is the equivalent of what you eat.
Imagine that two people are trying to lose weight, both using totally different strategies. The first person’s strategy is to eat healthy and every day write down what they eat and when they eat it. The second person’s strategy is to weigh themselves on a daily basis and see how their weight changes. This person is not going to do anything differently except weigh themselves on a daily basis. Which person do you think will have better long-term weight-loss success?
Strategy A vs Strategy B
I am using this as an analogy for investment management, where what you own is the equivalent of what you eat. In my opinion, if you want to get good long-term investment results, your entire focus should be around what you own and when you bought it (or plan to buy it). Whenever we review an investment portfolio, the first thing we look at is what’s in the portfolio. We are looking specifically at these things in this order:
- Total asset allocation – what portion is in stocks vs. bonds. Of the stocks, are they all U.S. companies or do they have international and emerging markets countries as well? Of the bonds, are they corporate bonds, municipal bonds, government bonds, etc.?
- Concentration– is the portfolio overly concentrated in one area, like technology or financial services? In 2000-2002 the large US stock market suffered severe losses while real estate and bond mutual funds were actually up during those same years.
- Timing– When were the investments purchased? Risk can be defined in two ways, volatility (how much the price fluctuates), and loss of principal. We are more concerned with loss of principal than we are with volatility. If you bought an investment at its all-time high and it’s since dropped and has yet to recover, it’s possible you paid too much and it will never be worth what you paid. Conversely, it’s possible that you paid the right price and in the short-term, there is simply a gap between price and value.
I know many investors pride themselves on the fact that they login every day to their investment account to see what their portfolio is doing. And while I understand the emotional reason for doing so, I would argue that this is akin to weighing yourself every day and thinking it will cause the desired result. If you are going to look at your portfolio – and I certainly encourage you to do this AND get professional help while doing this – focus on what you own and when you bought it.
It’s my opinion that in the long run, a well-diversified* portfolio is a lot like a healthy diet: short-term results may vary but there are potential long-term benefits.
It’s my opinion that in the long run, a well-diversified* portfolio is a lot like a healthy diet: short-term results may vary but there are potential long-term benefits.
*Diversification does not guarantee a profit or protect against a loss.
