It's 420 day.
This is Colorado, land of legalized marijuana, but many other things happened on April 20th other than the consumption of pot. Sadly, today also marks the 17th anniversary of the Columbine shootings.
Our investment team here at AIFS thought you might enjoy an exposition of a handful of common investment mistakes. This is the first in a series, and we hope you learn and benefit from them.
One of our investment partners calls diversification "global mush." You own so many investments it's a collection, not a portfolio. What you end up with is an expensive index fund that may never amount to anything.
Spreading your risk over a wide array of investments is prudent. However, owning a little of everything delivers everything, which is to say very little, on average, and it has nothing to do with your individual situation, goals, financial plans, and values.
We see it all the time. Your friend reads Forbes magazine or one of its cousins and sees an article, "The Hottest Funds to Own Today" and buys one. Next year he repeats. After seven years he has seven funds that all own basically the same stuff, are all expensive, are the least effective, index fund on the planet. Maybe one of them delivered a return close to what he hoped for when he was dating the fund in January, years ago.
As our friend, Nick Murray, puts it, winning the relative performance game is like Miss America; nobody wins twice.
Chasing performance is one reason a person can create a portfolio of global mush. Another reason is almost the polar opposite: we are afraid. In 401(k) world, they call it the 1/n phenomenon.
Given a list of 10 investments, we put a little in all 10, or 20, or whatever "n" of investments there are to choose from. We've assured ourselves that not any one of them will kill us, but have no real reason for doing it other than "fear" of being killed by any one of them... which is a topic for next time.
What can you do? Focus on what you can control. Focus your goals, your values, the timeframe for when you need the money. Engage a financial advisor as your guide. Sometimes investment X does better, sometimes investment Y, and we'll never know in advance who, when, or by how much. Our ability to handle the unpredictableness of markets is a very large determinant of our long-term investment returns--much more than any amount of diversification ever will be, and no amount of overdiversification can give us enough good feelings to overcome its costs and inefficiencies.