Bryan Binkholder Talks About the Advantages of Being Average
I’ve always been athletic. More specifically, baseball has always been my thing. I played when I was growing up and all the way through college. Sports brings out that competitive spirit, that part of us driven to excel, to win, and to be the best possible version of ourselves. It is this drive to win that pushes us past our physical limits when we train and keeps our focus steady on the prize.
So, why would we ever want to be average?
We wouldn’t. Average feels like ‘settling.’ It’s what you get when you don’t really try, when you’ve given up on your big dream, right? Well, this may be true in sports, in business, and in many other areas of our lives. But there’s one area where average is the clear winner, every time, –investing. How can average be our goal? Glad you asked.
Diversification: The Quest for Average
Rather than attempting to pick stocks or sectors of the market that will outperform (otherwise known as stock picking and market timing), our goal is to move away from the crystal ball formula for investing and make “average” our goal. This is accomplished by having a truly diversified portfolio.
With a truly diversified portfolio, the risk factor is greatly minimized because all the variables that cause the most amount of risk are removed or greatly reduced. This is where being average, which usually sounds bad, is actually a great thing. Let’s take a look:
Most investors perform far below average after taking into account the fees tacked onto actively managed funds. If the fees were wiped away, then every year, half of all actively managed funds would outperform the index (since the index is the average). Well, the seemingly logical thing to do then would be to simply invest in these outperforming funds, but that can’t be done. With investing, as we are well aware, past performance does not guarantee (or even imply) future performance. One hurricane, one turn in the industry, one discovery by a competitor, one lawsuit, and a stock can plummet. There are no guarantees and there is no way to predict with any amount of accuracy, what tomorrow will hold. And besides, in the real world, there is no way to wipe away the high fees on managed funds. That means more than half of the actively managed funds usually underperform index funds over the long run.
The ideal then, is to have a truly diverse portfolio (I put an emphasis on “truly” because many investors falsely believe their portfolio is diverse just because of the number of stocks they hold). More doesn’t equal diverse. Your asset allocation strategy depends on your risk tolerance, your age, the amount of money you’re working with and your future financial goals, but the key to a diverse portfolio is to choose investments that don’t move together. By doing so, when one part of the market falls the other is rising, which keeps you at a nice average and helps you sleep well at night because you become familiar with the natural rise and fall of the market.
While the quest for average is the ideal, many (if not most) investors fall victim to the “go for broke” mentality. We end up wasting a good portion of our nest egg by greedily swinging from one end of the pendulum to the other. Market timing, chasing gurus and past performance, and then the occasional emotionally charged “getting in and getting out” of the market. They all take their toll and are all completely unnecessary.
Here are some additional transgressions/traps common to investing:
Company Stock – Because we can generally purchase company stock at a reduced cost, many tend to over-purchase. Being overweighted with company stock is common but greatly increases the risk factor, so should be viewed as unwise. Enron is a classic cautionary tale for this scenario. IN the company’s demise, the employees not only lost their careers, but may lost their future retirement savings as well.
Familiarity – We see this again and again. Professionals in any given career feel they have inside information because they have daily contact with a product or company and highly regard them. A prime example would be a surgeon loading up on a promising medical device company’s stocks. If he ends up overconcentrating in a single sector or position, he is putting himself at risk regardless how good the company may appear.
Failure to Rebalance – Selling off gains and buying up poorer performers. It’s investing 101 (buy low, sell high) but we often continue to hang onto gains and become leery about buying poorer performers. Why? Because investment ads continue to condition us to look at past performance, when it’s completely irrelevant (not to mention the fact that the performance numbers are manipulated to appear much better than they actually are). It’s all part of the game to get us off the “prudent path” of investing. Rebalancing is absolutely vital to a healthy portfolio.
Tips on Hot Stocks – Probably one of the worst things an investor can do to is pay attention to the self proclaimed stock jockeys who are all too happy to provide you with the latest hot stock tip. He is often so passionate and convinced himself that he’s got you sold after just a ten minute conversation around the water cooler. “It’s a sure thing. This could be the chance I was waiting for.” If you ever find yourself saying any of those things to yourself, –stop right where you are and regroup. This is a certain road to financial ruin paved with many who have gone before you.
Don’t allow greed or emotional hype to overwhelm you are cloud rational thinking. No single stock is ever such a sure thing that it warrants putting all (or a large portion) of your money into it.
By following the above guidelines, you’ll minimize investment risk and best of all, you’ll be able to sleep well at night. For more tips and sound investment advice contact Blue Ocean Portfolios and continue to learn from the insights we freely provide here and on The Financial Coach Show website.