Does a Rising Tide Really Lift All Boats?Submitted by Bernhardt Wealth Management on October 29th, 2018
Notwithstanding the stock market’s recent volatility, we have seen some strong returns from equities, if we take a historical viewpoint. After losing 37 percent of its value during 2008, the S&P 500 returned an average of 15.62 percent for the next nine years. Generally speaking, those who rode out the tough year and remained invested in stocks saw the value of their investments recover and exceed previous levels by a respectable margin.
But we need to remember that the S&P 500, like the Dow Jones Industrial Average, is an index made up of the stocks of a number of different companies. We should also keep in mind that all of the stocks in the S&P 500 did not fare equally well during the rising market of the last ten years.
A recent analysis by Salt Financial indicates that the big tech stocks—sometimes called the FAANG stocks, an acronym for Facebook, Amazon, Apple, Netflix, and Google—may have accounted for a disproportionate amount of the rise in the S&P 500, especially during the run-up that we saw in the first nine months of 2018, prior to the recent volatility. Even more suggestive is the observation that it was perceived earnings weakness in the tech sector that contributed to the recent selloffs in the stock market.
The old stock market adage, “A rising tide lifts all boats,” is often, as with many financial proverbs, an oversimplification. Certainly, in the case of recent gains in the stock market, most of the uplift was coming from a relatively small number of very large-capitalization stocks. The top five highest-performing stocks in the S&P 500 index for 2018, for example, contributed more than 40 percent of the overall gains in the index. That’s a lot of boats left stranded on the beach!
One principle borne out by this information is the crucial importance of diversification. Suppose an investor owned every stock in the S&P 500 except the five that proved to be the year’s highest performers. That investor would have missed out on 40 percent of the gains to be had for the year. Of course, none of us—investors or investment advisors—have a crystal ball. We can’t pick the five, or ten, or even hundred stocks that will provide the majority of the gains or the smallest downside risk for any given year.
Instead, the answer to this problem is diversification. By owning a widely diversified portfolio made up of assets that tend to not move in the same direction at the same time and that tend to have different types of vulnerabilities—because every asset has vulnerabilities—we don’t have to guess right every time. Instead, we position our portfolio to benefit from a wide variety of circumstances and also to be shielded, at least somewhat, from a wide variety of risks.
A professional advisor can help you look at your portfolio to see if your diversification strategy is working optimally for you. If you have questions, we can help you find the answers.