Carrying on from last week’s blog, I did promise to let you have our solution to dealing with uncertainty. We believe the very best tool for dealing with this issue is diversification. We allocate part of your investment to conservative fixed income investments to provide stability when equity prices fall and to rebalance into when equity prices rise. In addition, we also diversify the equity portion of your portfolio across international markets and types of companies.
In some instances, the entire stock market can move in unison. However, that is not always the case and different asset classes often behave differently at different times, but all have strong long-term performance characteristics.
As a recent example of diversification in action, consider the following difference in returns that even a single quarter can make;
4th Quarter 2016 UK Overseas
Large Company Stocks 3.89% 7.08%
Value Stocks 4.19% 11.17%
Small Company Stocks 1.48% 8.01%
1st Quarter 2017
Large Company Stocks 4.02% 5.1%
Value Stocks 1.0% 3.0%
Small Company Stocks 5.1% 4.0%
During the 4th Quarter of 2016 overseas stocks significantly outperformed UK Stocks and this was mainly because of strength of both US Companies and the Dollar. The very next quarter the returns are generally aligned with each other.
You might think that if we were clever, we would be able to predict which is likely to outperform from quarter to quarter, but nobody can do that despite what they may think.
Over the long-term the expected returns of UK and Overseas stocks are similar, but as demonstrated here there is a diversification benefit to holding both. The benefit of a diversified portfolio is a smoother ride and a reduction in the uncertainty that can and will happen.
In short, we will never own enough of one thing to make an absolute killing, but in so doing we won’t own enough of one thing to get killed! If you have a reliable financial plan in place, you don’t have to make a killing to accomplish your goals. We believe the market return, which is there for the taking, is often sufficient to achieve a positive outcome to a solid financial plan.