In my decades-long investment career, this current season is undoubtedly the most puzzling that I have ever witnessed.
From one vantage point, I look out on the world and I see the devastating personal and economic effects of our battle against the deadly Coronavirus. I see an economy that has stumbled badly and has yet to get back to its previous stride. Many industries continue to struggle and small businesses are closing daily in our communities. As a result, there are now 10 million fewer Americans employed than there were one year ago. Civil unrest has sadly become commonplace and political divisions are cutting deep into the fabric of society, friendships, and families. Oh, and let’s not forget that our national debt is skyrocketing!
Yet from another vantage point, as I look out on the capital markets, I see an amazingly resilient stock market near record highs, rebounding remarkably from its 34% plunge (S&P 500) last year, housing prices doing likewise, and bond prices remaining stable. Companies are showing adapt ability and innovation as they pivot their business models to the new realities of daily life. As monetary and fiscal stimulus spigots run wide open, investors foresee bright corporate prospects on the horizon pushing valuation metrics to historically high levels. I even see signs of outright ebullience as “investors”(speculators?) flock to Initial Public Offerings (IPOs), Special Purpose Acquisition Companies (SPACs), “Meme stocks”, Bitcoin, and even trading cards.
So given this dissonance, what is an investor to do?
In my experience, the Bible actually provides some great advice on how to approach very uncertain conditions, including business ones. In fact, in this passage above from the Book of Ecclesiastes, we find the only time that “investing” is specifically mentioned in The Scriptures. Here, in chapter 11, the author (Solomon?) suggests that one should invest in as many as seven or eight ventures because one could not know what disasters might come. This is reminiscent of the idiom that many of us learned as children, “Don’t put all your eggs in one basket.”
In investing, we call this many ventures strategy “diversification”; spreading out one’s portfolio across a number of investments with differing types of risks and commensurate returns to be expected. Examples of some of the possible investment components of a prudently constructed portfolio include: US Stocks (Large, Mid-Size, and Small Companies), US Bonds (Treasuries, Municipals, Investment Grade, and High Yield), International Stocks (in Developed as well as Emerging Market countries), Real Estate Securities (REITs), Commodities, and Private Investments.
For many, diversification can seem boring as investors pursue steady returns rather than seeking to jump to the next investment which will outpace all others. Indeed, some even call it “diworsefication!" As humans, we oftentimes are captivated by stories of those who “go for it” and are “all in” on a business concept. We love to read books and watch movies about entrepreneurs, sports figures, entertainers, leaders, artists, et. al who have risked everything for a singular idea. Indeed, this is oftentimes how tremendous wealth is created; by having a good idea, working really hard and taking audacious risks. However, it has been proven repeatedly that wealth is preserved and prudently grown through diversification.
A well-diversified portfolio will never be the best performing portfolio during any given time frame, but it will never be the worst one, either. Its performance will be somewhere in the middle, but much more stable. Enjoying much of the upside while protecting against the downside, that possible “disaster” referenced in Ecclesiastes, is the goal of a diversified, “all-weather” portfolio. The simple math is that a narrowly focused portfolio which suffers a 50% decline, then will require a 100% increase just to get back to even. Meanwhile a diversified portfolio which loses 20%, then needs only a 25% return to fully recover.
Any good basketball coach knows the importance of diversification. While a team may be exceptionally strong at shooting, a good coach will not rely solely on her players’ offensive prowess to win games. Instead, a wise coach employs a strategy of diversification, instructing her players not just to focus on shooting, but also on passing, rebounding, dribbling, and of course defense. That’s how games are won! So, likewise with investing!
Therefore, as I look out on our current economic and market environment and not knowing what disasters (and blessings) may come, I say that the wisest strategy is to invest across many ventures!
Sources: U.S. Bureau of Labor Statistics and Standard & Poor’s
Dr. Erik Davidson, CFA, is the Chief Economic Advisor for Inspire Investing. Previously, Dr. Davidson served as the Chief Investment Officer for Wells Fargo Private Bank, overseeing more than $200B in assets. Dr. Davidson holds a doctorate degree from the DePaul University’s Kellstadt Graduate School of Business with his research focus in Behavioral Finance.