As someone who focuses on working exclusively with people in Pharmaceuticals there's some common topics I often come across.
There's a lot of smart people in the industry and as a result there's a large amount of people who fall into the DIY or "Do it yourself" category of investing.
That is, they enjoy handling their investments themselves and aren't worried about outsourcing that to another person or investment company.
And to be honest if that sounds like you that's completely fine, it's actually one of the main reasons why I don't require any investment to work with someone and why I offer financial planning services regardless of whether or not someone wants to invest money with me.
The problem is when those people don't exactly have the best understanding of their investment strategies.
And that brings me to one of the most commonly heard DIY topics I come across...
S&P, S&P, S&P!!!
"I will just buy the S&P 500."
I've lost count of how many times I've heard someone use this as their prime investment strategy. And look there's nothing wrong about buying a passive ETF that tracks the S&P 500 (assuming that's what that person means when they say that).
It's just that if you're trying to have a well diversified portfolio, as in the old saying "don't put all your eggs in one basket", this is not exactly your best strategy.
Let's start with what the S&P 500 is - an index made up of a collection of 500 large US companies.
500 different companies sounds like a lot. Certainly spreading investment amongst that many companies would be diverse?
Except the S&P 500 is weighted by market capitalization, meaning each of those companies doesn't just represent 1/500th of the index.
Instead the bigger the company the larger influence it has on the S&P 500's value.
If you actually break down the weighting of each company you'll find that the top 10 stocks represent almost 30% of the entire index.
Meaning if that's your only investment you've actually got a lot of eggs in the same basket.
Asset Classes
"But nothing ever beats the S&P!"
Yeah this is just wrong, but is another claim I've heard from DIY investors.
The S&P 500 is just a collection of stocks - it is not particularly unique and it is certainly not some magical investment that is always the best performer.
In fact if you look at the stocks that make up the index you'll find that the S&P 500 falls under what is considered the Large Cap Asset Class.
There are way more Asset Classes out there - Small Cap, Mid Cap2, International, Emerging Markets3, Fixed Income, etc.
When you map these out and compare the best and worst performers year to year Large Cap is certainly not the winner every year.
(Click to view the full size image.)
In fact it's actually pretty common for top performers to underperform the following year, and vice versa.
So is relying on one asset class really the best strategy?
The Power of Asset Allocation
So since every asset class has the ability to be the best from one year to the next but you don't know which it will be what should you do?
Maybe you should hold a little bit of each and really diversify your portfolio.
If you've ever heard the term "Asset Allocation" this is what that's referring to.4
By holding a little bit of each asset classes you're not necessarily going to be getting huge returns each year.
By its design you'll never beat every asset class in any given year, because you'll always hold a bit of the bad performers along with a bit of the good ones.
But instead the idea is to smooth out your ups and downs and decrease the volatility in your investments.
This becomes especially important as you approach retirement age, as a surprise drop in the stock market close to retirement could have severe repercussions if you are overly aggressive and haven't properly decreased your risk tolerance.
The beauty is if you're a DIY investor you don't necessarily have to be an expert in every possible type of investment - it's pretty easy to find some asset allocation models to get an idea of better ways to diversify instead of relying solely on one type of asset class or index.
Even if fees are a concern, which is a big reason I find many are drawn to doing things themselves, there are plenty of ETFs that track indexes across various asset classes with fairly minimal fees.
And if you're curious how that might fit into your own financial plan?
Schedule a call with me and I'll help point you along the right direction.
It is only 30 minutes, doesn't cost anything, and there are no obligations do to anything after you call.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. There is no assurance that the techniques and strategies discussed are suitable for all investors or will yield positive outcomes. The purchase of certain securities may be required to effect some of the strategies. Investing involves risks including possible loss of principal. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
1. S&P 500 is an unmanaged index which cannot be invested into directly. Past performance is no guarantee of future results.
2.Large-caps are generally safer investments than their mid- and small-cap counterparts because the companies are more established, but their stocks may not offer the same potential for high returns. The prices of small and mid-cap stocks are generally more volatile than large cap stocks.
3. International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. These risks are often heightened for investments in emerging markets.
4. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Asset allocation and diversification does not protect against market risk, nor ensure a profit or protect against a loss.
ETFs trade like stocks, are subject to investment risk, fluctuate in market value, and may trade at prices above or below the ETF's net asset value (NAV). Upon redemption, the value of fund shares may be worth more or less than their original cost. ETFs carry additional risks such as not being diversified, possible trading halts, and index tracking errors.
No investment strategy assures a profit or protects against loss.