Although many spend a lot of time trying to, no one can accurately predict the future. If I could, I doubt the Governments of the world let me spend my time dealing with investment portfolios.
Because we do not know which investments will outperform, we invest money into a wide variety of them. We know that different types of investments tend to complement each other. When some fall in value others go up. We call this being “diversified”.
Diversifying money into different investments allows us to, in theory, hold a more “efficient” portfolio.
This means two things. One is that for the same level of risk, we could earn higher returns. The other is that we could achieve similar returns whilst taking less risk.
Whilst this sounds good there is a catch. Being diversified means there will be a part of your portfolio which is not doing well.
(As an aside, if every investment you own is outperforming, it means one of two things. One is that you are lucky. The other is that you are not actually diversified. I always assume the latter.)
But what is wrong with some of the investments not doing as well as others?
Studies have found we tend to feel more pain with losses than joy with gains. We also tend to focus on a small element of something rather than the big picture. If an element of a portfolio is not working, then the wider portfolio is flawed, even “risky.”
Finally, there is the phenomenon of “if only.” How we benchmark success is a key determinant of happiness. If we measure success by comparing all investments to the top performer, we will never be happy. It is natural to think “if only a lot more of my assets were investing in XYZ fund….” But a mindset of chasing “what is working now” is the worst way to meet your long-term financial objectives.
We often feel like we have to “do something”. However, staying the course is doing something and is well worth doing.
Whilst it is good for us, diversification can be a bitter pill to swallow. The path forward is not to rethink diversification, but to accept and think through how it makes us feel.
One way we help our clients with this is to help them focus on the long term. Most of our clients are investing for decades and their planning reflects this. We reinforce at every stage how essential being diversified is to achieving long term financial goals.
