One of the most common, and arguably one of the most costly, mistakes made by many investors is making investment decisions based solely on past performance.
Many investors assume that investments and asset classes that have earned above-average returns in one year will continue performing well the following year. As a result, they invest the majority of their retirement savings in the one or two asset classes with the best recent performance.
Doing this is, basically, the equivalent of putting all of their retirement savings nest eggs in one basket.
The accompanying chart shows how nine asset categories of stocks and bonds performed from 2014 to 2020. The best-performing asset class for each year is in the top row, and the worst-performing asset class is in the bottom row.
If you track the performance of each asset class during the seven-year period, there is no consistent or predictable pattern. In terms of individual performance, all nine asset classes are quite volatile, going from best-performing in some years to worst-performing in others.
Based on these past returns, can you tell which asset class will be the best and worst performers over the next seven years? If you had to invest all of your retirement savings in one investment each year over the next seven years, which asset class would you choose?
The single most compelling reason to diversify across asset classes is that no one knows which asset classes will over-perform, or under-perform, from one year to the next. Markets and economies move through various cycles every year, and different asset class categories of stocks and bonds tend to perform differently during these cycles.
Successful investing should be based on proven investment techniques, such as asset allocation and diversification, rather than intuition and guesswork. Having a portfolio diversified across multiple asset classes during these cycles can help protect investors from uncertainty.
Martin Krikorian is president of Capital Wealth Management, a registered investment adviser providing fee-only investment management services located at 9 Billerica Road, Chelmsford. To schedule a free, no-obligation consultation and portfolio analysis, call 978-244-9254, or email firstname.lastname@example.org.