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Diversification

Your Portfolio vs. “The Market” – Comparing Apples to Fruit Salad

When you order fruit salad, you don’t expect it to taste like a single apple. If you’re invested in a diversified portfolio, it’s unrealistic to expect it to behave like Apple or even only U.S. stocks.

Articles by Nick Holeman, CFP®

By Nick Holeman, CFP®
Financial Planning Expert, Betterment  |  Published: November 30, 2018

There's nothing more appealing than apples in season. The same might be said for Apple and other U.S. large company stocks.

You can predict apple season, but not “Apple season,” i.e. when the U.S. stock market will outperform.

Being invested in a globally diversified portfolio means you can get a sweet taste of various markets’ highs, but you aren’t as exposed as you might be to any particular market’s lows.

This article was originally published by Betterment on Business Insider.

Recent market volatility notwithstanding, U.S. stocks remain near all-time highs. If your portfolio isn’t performing as well as you expect it to, you may be wondering what to do about it. Is it time to dump your current basket of investments and look for greener pastures? Assuming you have an up-to-date financial plan in place, the short answer is: probably not. Here’s why.

Nothing Beats Apples in Season

At the height of apple season, there’s nothing more tantalizing than a Honeycrisp straight off the tree at a pick-it-yourself orchard. Investors in Apple and other large U.S. companies have reaped similarly outsize rewards recently, as “the market” has experienced what seems to be an endless summer.  Let’s call it “Apple season” with a capital “A”.

Feeling like you’re on the sidelines during apple season — or “Apple season” — can result in a serious case of FOMO (if you’re not familiar, that’s a “fear of missing out”). And it can tempt you to do whatever is necessary to fully partake in the harvest. That’s understandable – and pretty low risk if you’re talking about real apples. But if it means pushing the reset button on your investment strategy, you’d be wise to think twice.

The problem is, while farmers can fairly reliably predict apple season, markets, unfortunately, don’t have a predictable cycle. Unlike apple season, “Apple season” doesn’t necessarily come once a year. And there’s no telling how long it will last or when it’s at its peak.

Here’s Why You Should Go for  Fruit Salad

The desire to mitigate downside risk is a big reason why financial advisors recommend a globally diversified portfolio—i.e. the fruit salad of investing strategies, if you will. Because Apple season doesn’t last forever, you can hedge your bets by building a portfolio with a mix of components known to “ripen” at different times.

But when it comes to investing, that’s only half the battle. The real trick is to stick with your strategy long enough for it to bear fruit. Having appropriate expectations is key.

The best way to measure your investing success is not by whether you’re beating the market but by whether you’ve put in place a financial plan and a behavioral discipline that are likely to get you where you want to go.

– Benjamin Graham, investing legend and mentor to Warren Buffet

Think of it this way: When you order a fruit salad, you don’t expect it to taste like a single apple. Similarly, if you’re invested in the portfolio equivalent of a fruit salad, it’s unrealistic to expect it to behave like Apple or even like the overall US stock market.

That’s because you own assets chosen precisely because they don’t behave like the S&P 500.  This might include:

  • Small and mid-size company stocks
  • International stocks from developed and emerging markets
  • Real estate
  • Alternative investments
  • Bonds

Because these assets may zig when U.S. markets zag, they work in concert to help smooth out the bumps that an non-diversified portfolio would experience. That’s true for upswings as well as downturns.

With a globally diversified portfolio, you are not missing out on “Apple season”; you’re intentionally partaking, just in moderation. Not all individual components are at their best at any given time, as shown in the Callan Periodic Table of Investment Returns. Over time, a diversified portfolio aims to seek returns without as much overall risk. The downside? In exchange for potentially avoiding a worst case scenario, you may trade off the chance for experiencing the highest gains. If you want the highest possible reward, then you have to be willing to put your money all into the same riskiest kind of fruit.

Before You Change Your Order

As this is being written, the headlines in the financial media have been whipsawing along with the market. “Wall Street drops as Apple slips,” read one. “The factors that helped U.S. stocks to solidly outperform other global equity markets this year faded sharply last week,” according to the Wall Street Journal. The very next day was the market’s “best day since April,” per CNBC.

Is it the end of “Apple season” or merely a blip? Unfortunately, there’s no way to know for sure.  The good news is you don’t need to. The investing equivalent of fruit salad sees some of the gains from an “Apple season” but with other components that smooth out effects whenever “Apple season” ends.

So before you trade in your fruit salad for whatever’s now in season, consider this: Your portfolio may well be doing exactly what you asked of it. Being invested in a globally diversified portfolio means you get a sweet taste of various markets’ highs, but you aren’t devastated by any particular market’s lows. Or, put another way, one bad apple won’t spoil the whole bunch.

Be Fruitful And Let Your Portfolio Multiply

It’s hard to resist a shiny, ripe, red Apple, but appearances can be deceiving. If a single market’s outperformance tempts you to abandon your investment strategy, take a moment to step away from the table. Advisors recommend globally diversified portfolios because they offer the best balance of risk and reward for your personal financial goals, situation, and temperament. If that’s still true, do yourself a favor: Turn off the financial news, banish the FOMO, and maybe head to a real orchard instead. Your portfolio and your palate will thank you.

Still have questions or concerns? Consider talking to a Betterment financial expert.

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