Stressed Investors Shouldn’t Change Lanes

A new client recently looked at one of our recommended portfolios and was concerned. He wrote: “I understand the idea of spread the assets as broadly as possible to play the ‘market of markets,’ but I have some concerns. You recommend the Vanguard Foreign Small Cap …really? Down 20% in the last year. And the Schwab Large Cap Foreign is primarily European. Seems to me that it isn’t a particularly good time to get into Europe, but it needs to be part of a portfolio at some point. Maybe not now. And Schwab Emerging Markets? Well, the last year saw a 19% decline. Brazil isn’t doing as well as it was, same for China, Russia, Taiwan and the rest. The world economy isn’t going to bounce back. Again, emerging markets needs to be in the portfolio, but perhaps wait to see how things change. Thoughts?”

These are times when the anxious investor can easily panic. Every day brings new worries, concerns and signs of optimism. Economists are talking about extended weak growth and how we have kicked the debt can down the road and now must pay. So what should an investor do?

Rebalancing for the long haul

An investor who is constantly shifting allocations in search of returns is similar to a stressed-out driver trying to make her way on a Friday afternoon before a holiday down Interstate 405 in Los Angeles, the nation’s busiest stretch of highway. Traffic is at a near standstill, but the driver is determined to get to her destination on time despite the fact that some 320,000 other drivers are trying to do the same.

This harassed driver seeks to dart from one lane to the next in the hope of finding some small advantage. Her lane grinds to a crushing halt while the drivers four lanes over seem to be effortlessly slipping by. With great consternation, the driver, slowly but determinedly, works her way over, one lane at a time, rudely nosing her vehicle into tiny spaces to reach the sought-after lane of freedom.

For a few brief moments a wave of satisfaction washes over the driver as she hits her accelerator and pops up from five to 30 miles per hour, finally passing that old woman who had crept along in front in the silver Camry, oblivious and out of touch. But then it happens. Her new lane grinds to a sudden and dangerous halt. She is at a standstill. The frustration builds. Then, as she looks to her left, she notices that the lane from whence she came is now moving freely. As she tries to creep her way back, right there before him the silver Camry slips by, the happy old woman smiling away, at peace in the midst of the 405 storm.

Driving home a point

This driving metaphor provides an interesting allegory for investing behavior. Globally diversified investors own thousands of companies in many countries and economies. Sometimes these economies enjoy stretches of unfettered growth that is celebrated and enjoyed by all — not dissimilar to flying down the 405 on a Sunday morning. Then there are times when these businesses and economies become cramped and overburdened. Growth painfully slows as these economies right themselves from a traffic jam.

The wise investor learns that these patterns are essential and expected components of all economies that should not have much effect on investment patterns. By accepting the simple fact that she cannot outperform the market, the wise investor can rest at ease knowing that a well-diversified portfolio will reap a reward. Like the happy old woman on the 405, this investor isn’t thrilled that the economies are moving slowly but accepts that disruptions are part of the investment journey. Although she enjoys years of high, double-digit returns, she accepts that her portfolio will also move slowly at times. There is no need to change lanes.

Most detours are short-lived

During periods of slow growth, each investor has a choice. She can chase after the fast-moving lane, or jump from one allocation to the next, in search of a miracle, or she can accept the seasonal slowdown, trust her allocations, turn on her favorite radio station and, like the old woman on the 405, enjoy the journey.

The statistics show, for most investors, making significant changes to a portfolio’s allocation is expensive and usually unfruitful. Tax friction and trading costs burden such lane-changing investors with a disadvantage that must now be overcome with dramatically increased growth. Once such an investor adjusts her allocation, the news hits, economists speak, and it is time once again to make more changes. Sometimes the investor will get it right, and others, be stuck in the slow lane while others whiz by. Europe? Emerging markets? Small-cap stocks? Sure — own them all and buy more. Tomorrow’s winners will be today’s losers.