Every now and then the markets teach us an unpleasant lesson: Not all stocks or types of stocks (e.g., domestic or international) go up and down at the same time. We design portfolios with that in mind to try to avoid perfect correlation. When the stocks we own go up, especially in relation to stocks other people own, we call that being smart and savvy investors. But when the stocks we own do worse than stocks owned by others, we may get upset. We may even be tempted to make big changes to our portfolio in an attempt to get the better returns that others seem to be enjoying. But making investing decisions based on what’s happening in the short term is a bad idea.
Diversification Is Like Insurance
Here is a quick example: In 2014, the S&P 500 Index was up 13.69%. The same type of index for international stocks (MSCI World ex U.S. Index net div.) was down 4.32% for a spread of 18%! What are we to do? Panic? Is now the time to get out of international stocks? Or is this just the price of diversification? For reassurance, check out Larry Swedroe’s recent blog post on the topic, which speaks to this phenomenon.
As Larry says, “Try thinking of it this way. Diversification is like insurance. It’s insurance against having all your eggs in the wrong basket. And a strategy that involves buying insurance is working whether or not you collect on the policy. I don’t know of anyone who complains when they don’t collect on their life insurance policy, but I know many people who complain when their diversified portfolio underperforms.”
“Diversification is like insurance. It’s insurance against having all your eggs in the wrong basket.” – Larry Swedroe
Temperament, Not Intellect
Warren Buffett has said that “the most important quality for an investor is temperament, not intellect.” He has also advised that “success in investing doesn’t correlate with IQ. … Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people in trouble investing.”
Be careful not to judge a strategy by short-term results. Sometimes, even with the right strategy, it just takes patience to achieve one’s goals. Tracking error regret is not an “error” unless we make investing decisions based on recent market events. That’s when the real errors start happening.