Our Thoughts on Investing in Uncertain Times
So, what’s the best response when faced with market uncertainty? An investor’s best friend is diversification. Unfortunately, what some investors do is diversify into the investment that has done the best lately. We’ve had many conversations with folks that wanted to put more money into an investment that had done really well recently. While it may feel good to invest in a recent winner, the fact that an investment has gone up recently doesn’t provide any insight into whether the investment will do well in the future.
Research by a company called DALBAR has shown that investors are their own worst enemy when they chase returns. DALBAR tracks inflows and outflows of all mutual funds in the U.S. They have found that the average investor underperforms the average mutual fund by 1-2%. This is because the average investor buys high and sells low. In fact, here’s some information form JP Morgan that shows the average returns of various asset classes compared to the return an average investor gets:
It may seem like the logical solution would be to just invest in the highest returning asset classes – REIT’s and Emerging Market Equities. Unfortunately, those asset classes also have some of the highest volatility. Most investors would not be able to stomach the ups and downs of those asset classes. Moreover, from experience we find that often the highest returning investment in one year ends up being the lowest returning investment in the next year.The following chart shows asset classes ranked by their returns each year since 2006:
It’s interesting to see that commodities and REIT’s were the worst performing asset classes in 2020 but have been the best performing asset classes in 2021. By combining asset classes into a diversified portfolio, you will achieve more consistent returns over time. You will never have the best performing portfolio, but you will never have the worst performing portfolio either. One last benefit is that if you have a disciplined process to rebalance a diversified portfolio, you will more likely buy low and sell high.
If you would like to discuss you're investments with us, feel free to contact us.