We Just Killed It With That Investment…

stick-to-your-plan-diversification-wins

Royal Bank of Scotland (RBS) in a January 12, 2016 note to their clients stated and in quotes “Sell everything except high quality bonds. This is about return of capital, not return on capital. In a crowded hall, exit doors are small.” That note was especially bearish on emerging market assets. What were we doing? We were backing up the truck and continued to do so not only for our personal accounts but for many of your accounts with not only emerging market stocks and bonds but a variety of other investments, not because we knew or had better insights than say RBS but because your plans demanded it. And that’s the big difference. So how did we do since that RBS proclamation? The chart below is the performance of three different emerging market equity investments we typically use for many of your portfolios. Average gain ~ about 50% excluding dividends.

emerging-markets-rbs-sell-everything-warning

The point here is not to gloat about the profit we have made since then but to point out a few important lessons we can take away from this episode.

  1. RBS or Goldman Sachs or Merrill Lynch or that analyst on CNBC does not know you, does not know your goals, does not know the path you are going to take or the map (that featured image you saw, now you know the context…) you are going to follow to get there and hence acting on whatever they say is not gonna be good for you. It might work in the short run but over many decades, nah…
  2. This is what reversion to the mean is all about. For a few years before that, emerging market equities and fixed income investments were down in the doldrums. Things were looking so bleak and press about them was so bad that it got real difficult to bring yourself to own these assets. But like always, when no one expects, the unexpected happens.
  3. Okay but you say that this stock I own has done even better. So what’s the big deal? But there is a big difference because what matters is not just returns but risk-adjusted returns. A couple stocks versus a basket of stocks that represent a sector or an asset class are two different beasts. We can apply statistical techniques to build portfolios that optimize that risk-return trade-off with a diversified basket of stocks or bonds. Doing that with a stock or two is utter foolishness and hence your spectacular returns that you made by taking on uncompensated risk don’t count. It counts but it doesn’t.
  4. So you made 50% on a $100,000 investment. Big deal. You should be pissed and annoyed that this asset or the market in general is on a tear – because you likely have decades ahead to invest and feed that plan and anything you buy now is that much more expensive so yes, you should be happy but then you shouldn’t be.
  5. And that brings us to this fixation on returns. Yes, returns are important but returns over decades. Anything and everything can happen for timeframes that aren’t measured in years at the very least and ideally in decades. And we understand that it’s tough to hang on when a particular investment in your collective portfolio is not doing that great when everything else is growing. But as the saying goes, you are not truly diversified if any part of your portfolio does not suck at any given time. And right when you feel like throwing up about a particular segment of your portfolio is precisely the best time to make an investment in that investment (ha…). And hence this story about emerging markets but it could be about anything.

So enough of these lessons and now onto investing.

Until later…

Image credit – Pixabay