Resources/Weekly Insights

Volume 13, Edition 29 | November 9 - November 15, 2024

Diversification: The Balanced Diet of Investing

Doug Walters, CFA

This week we continue our focus on our Guiding Principles with a deep dive into the importance of Diversification – the one free lunch in investing.

Contributed by Doug Walters, David Lemire, Max Berkovich

This week we continue our annual series on our Guiding Principles. Last week we kicked off with patience. Today we focus on diversification. If there is one topic we have hammered in 2024 it is diversification. There’s good reason for this – it is the most important investment management fundamental yet is frequently misunderstood. So even though I’ve used the word “diversification” at least 20 times in Insights over the past six months, we’re going to hit it again.

An Image Problem

Diversification has an image problem. Over short periods it rarely brings joy. I see this manifested in two ways:

First, there’s the “best performer” problem. At any given point there is a best and worst performer within a diversified portfolio. Regardless of how well and logically the portfolio is constructed, the question comes, “why didn’t I own more of that best performer?” Unless you have crystal ball, you will never solve this “problem.” The best you can do at any point in time is ensure you have a best-in-class diversified portfolio built to match your risk tolerance.
Second is that diversified investors never “feel good.” When the stock market is ripping, they’ll be suffering from FOMO, wishing they had a more risky portfolio. When the stock market is falling, they’ll likely outperform, but their portfolio will be down. So again, they don’t feel good. Over time, they are winning, but it rarely feels like it in the moment.

A Balanced Diet

Good analogies are tough to come by with diversification, but a balanced diet hits the mark. Just as our bodies need a variety of nutrients to function optimally, our portfolios need a mix of different asset classes to achieve the best long-term results. It’s basic science.

It may feel great for a short time to gorge on high fat, high sugar foods. We’ve all been there, but we know over time, where that leads. The same is true of investments. Imagine your investment portfolio as your daily diet.

Proteins are essential for building and repair, like bonds, providing the base upon which to grow.
Carbohydrates are a source of energy, like stocks, giving a portfolio a source of volatility and growth.
Add in sources of health fats, vitamins and minerals and you have a well-balanced diet. Our preferred mineral to add diversification to your portfolio is Gold.

In the moment, it might not feel good to pass on dessert or close that bag of potato chips, but we know with scientific certainty that such actions are recipe for a healthy body and increased longevity.

Likewise, we know that diversification improves the risk-adjusted returns of investment portfolios. It would be fiduciarily irresponsible not to take advantage of this free lunch.

Diversification in Real Time

In 2024, we’ve seen US Large Cap equities and Gold drive portfolio returns. Returns of most other asset classes were lower. Let the FOMO begin! It is only natural to look at those returns and wish you had more. It’s no different than watching a horse race and wishing you had put more money on the winner. But if you have a well-diversified portfolio*, built with a risk that matches your personal risk tolerance, then your portfolio did exactly what it was supposed to do. Congratulations!

As we approach the new year, celebrate a disciplined, balanced diet of investments, and have peace of mind knowing they are helping to improve the health of your financial plan.

* There’s a difference between a “diversified portfolio” and a “well-diversified portfolio.” A well-diversified portfolio seeks to maximize risk-adjusted returns rather than just adding diversification for diversifications sake.

2.6%

CPI inflation

Consumer price inflation was up 2.6% as expected.

Headline of the Week

An Economic Data Stew

A tough jobs report locked in last week’s interest rate cut but now stronger economic data is bringing a re-think to the timing and extent of further cuts. This week’s inflation report was in line with expectations but was a bit firmer. Consumers seem comfortable as spending was up in October. The Fed was quick to point out that there is still more data to come which could alter the flavor of this stew. But for now, they have introduced caution around the path for monetary policy. With the Fed’s dual mandate to focus on inflation and employment, the employment side seems tilted in favor of further cuts while the inflation side is a bit murkier. And we haven’t even mentioned (nor will we) the potential impact from the next administration.

The Week Ahead

A G20 meeting in Rio de Janeiro and speeches from several Central Bankers will allow earnings reports to step into the spotlight next week.

Chipping In

With a light economic calendar, earnings will take a more prominent role this week, with none bigger than the magnificent Nvidia, but there is more to chew on.

Nvidia’s market capitalization is over $3.5 trillion, giving it an edge over Apple for the biggest company, so it shouldn’t be surprising investors will be very focused on results Wednesday evening.
Nvidia’s data center revenue in the 3rd quarter is expected to have doubled from the same period last year to $29 billion, while overall revenue is expected to have increased by over 83% for the period.
Most importantly, with the stock up over 200% this year, it is future results, which are expected to be strong, but growing at a reduced pace that matters the most.
Based on option market data, the stock is expected to move by almost 8% in either direction.
While Nvidia is the belle of the ball, earnings from retail giants Walmart, Target, Lowes, Ross Stores and TJ Maxx, should offer a useful view on consumer spending going into Black Friday.

Side Dealing

The G20 meeting in Brazil, will feature all the major world leaders including President Biden, Prime Minister Starmer, President Macron, Prime Minister Modi, Chancellor Scholz and President Jinping.

Notably absent is Vladimir Putin. Instead Foreign Minister Sergey Lavrov will represent Russia.
The agenda for the Group of Twenty is not economic, rather it is social inclusion, global reform, and sustainability.
What should be of consequence to investors, however, are the side meetings after the official gathering ends.
President Biden has one scheduled with China’s Xi Jinping.

Talking the Talk

The calendar for next week is bursting with speaking engagements from many Central Bankers across the globe.

Traders will peruse words for hints at the direction of rates.
Governor Ueda of Japan and ECB president Lagarde are the marquee names to watch.

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