Swiss Army Knives and Diversification
Several years ago, I was running through an airport to catch an earlier flight home when I realized I was carrying my Swiss Army Knife I had owned since 1985. Rather than lose my knife, I checked my bag and opted for a later flight.
A Swiss Army knife is an invaluable tool. The knife's flexibility allows you to carry multiple devices with ease. At times, I'll use the knife, others the scissors or file. Can you imagine backpacking with a bag full of screwdrivers, knives, files, or scissors?
An easy-to-carry diversified tool is essential for hiking, climbing, skiing, and many more activities. My Swiss Army knife gives me confidence knowing I can access the right tool at any time. Like my knife, my diversified investment portfolio brings me faith and hope; a diversified portfolio is crucial for investment success.
Stocks performed well this past decade, rising 275%, but this hasn't always been the case. From January 2000 to December 2010, the S&P 500 lost 14% - the lost decade. However, bonds rose 43%, international stocks climbed 56%, and small-cap stocks soared 110%! If you concentrated your bets in large-cap stocks, you lost money, but you made money if you diversified your assets.
To grow your assets, you must own stocks. Since 1926, they generated an average annual return of 10% and produced gains three-quarters of the time. Stocks also help combat inflation. The S&P 500 is up 25.5% this year, while inflation averages 6.8%, so your net return is 18.7%.
Bonds are safe and conservative; they will protect your portfolio when stocks fall. Bonds are negatively correlated to stocks when one zigs, the other zags. The S&P 500 fell about 3% a few weeks ago, while bonds jumped more than 4%. Bonds also generate income, but they're not good inflation hedges. The 2-year Treasury note currently yields 0.7%. After inflation, your net return is a negative 6.1%!
Liquidity is necessary for all investors, and cash is king. An allocation to cash allows your other investments to grow while giving you access to your money without selling stocks or bonds.
In addition to traditional investments like stocks, bonds, and cash, adding alternative investments to your portfolio could give it a boost. A small portion invested in alternatives can help with diversification and growth, and allotting 1% to 5% of your assets is suggested. Investments in this category include real estate and commodities.
Most investors have a home bias. For example, US investors apportion most of their holdings to US companies, ignoring international markets despite more than 40% of the global capitalization located outside our borders.
Diversification is vital for long-term investment success because we never know when, where, or why certain asset classes will perform. A broad basket of securities based on your financial goals is paramount.
Despite a few moving parts, the Swiss Army knife is simple to use, and simple tools are the best. Your investment portfolio should be as simple as possible, but no less. A balanced account with low-cost funds is all you need to give you exposure to most markets without breaking the bank.
Like my Swiss Army Knife, I don't use all my investment tools simultaneously, but when I need them, I'm glad I have them. Large-cap growth stocks like Apple and Tesla have outpaced my other holdings by a wide margin this year, and my bonds and international stocks are lagging. When I review my laggards, I wonder if it makes sense to sell them and roll them into my winners. But I know the market will flip at some point and the losers will become winners. A diversified portfolio of low cost mutual funds is an investors ultimate tool.
We broke into Mir using a Swiss Army knife. Never leave the planet without one. ~ Chris Hadfield, Canadian Space Agency Astronaut
December 13, 2021
Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM's custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.
Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren't suitable for every investor.