27 Jul 2018 FOMO and Facebook: Why Diversification Matters

A couple of interesting things happened this week that led to this blog, but before I get to them, I want to start elsewhere.

I did a very bad thing before I sat down to write this, which was to get on Redfin and look at homes for sale in our neighborhood. After about two minutes of perusing the listings I stumbled upon this one, which can most accurately be described as The Home of My Dreams, and also, Not Particularly Close to Affordable for me and my family. And do you know something? Seeing that–that the home I would choose to build if I could was within blocks from my current home, for sale and also way too expensive for me–it sort of threw me for a loop. I had a visceral reaction to it that was entirely unreasonable and yet very real, something like envy and yet even more like fear. Fear that Raleigh’s crazy home market would push me out of a city I love dearly if we ever decided to move into something larger or nicer. Fear that I’m whiffing on an opportunity to time a move just right before Apple allegedly comes to town. Fear that my not being able to afford it says something about me as a person.

Fear of missing out.

Which brings me to the first of the two interesting things I mentioned. It was a conversation on Wednesday afternoon with a client about the performance of their investments so far this year. At one point in the conversation, the client said, “I just really hate fixed income.”

[An aside: Our portfolios use US Treasury bonds (bonds are also known as “fixed income”) as a way to hedge against equity volatility. They have historically offered a great hedge because they don’t move around in price nearly as much as stocks, and also because the relationship between Treasurys and equities–while not being perfectly inverse by any means–seems to be less correlated than just about anything else. This idea of having poorly correlating asset classes in a portfolio is part of what we mean when we talk about diversification.]

Back to the conversation: What the client was really saying as we looked at the performance of the different holdings in their portfolio was, “The bonds in my portfolio aren’t doing nearly as well as the stocks, and that’s hard.”

It is hard!! I don’t like it, especially when 2017 happened and stocks gave us something like 17% returns with hardly an ounce of volatility. As Charlie Bilello said recently, “Responsible financial advisors across the country are apologizing to their clients for the seventh year in a row. Why? Because the diversified portfolios they have built are lagging U.S. stocks … for the seventh year in a row.” So, seven years of seeing our portfolios earn less than a portfolio with 10% more U.S. equities, or 20% more, or—what if we added 30% more? Wouldn’t that be something?

It’s fear of missing out. A classic case of it, too.

Which brings me to the second of the two interesting things I mentioned. On Wednesday, within a few hours of the conversation above, Facebook released their latest earnings statement for Q2, and that statement said, among other things, that Facebook earned net income in the quarter—the quarter!–of $5.1 billion, and booked revenues of $13 billion. But one of the other things it said was that Facebook expects these crazy numbers of growth to slow down going forward, and so Facebook’s stock dropped 20% in after hours trading and did not really come up from that yesterday. So, to recap, if you had $100,000 of Facebook stock at 4pm Wednesday, you were holding about $80,000 of it as of 4pm yesterday. Perhaps enough to make you sweat! And yet, as Michael Batnick pointed out yesterday, nothing out of the ordinary for a stock like Facebook.

Do you know what the Vanguard Total Stock Market Index fund did yesterday on a day when one of the largest stocks in the entire world was down 20%? It was down 0.18%, which is to say, flat. That’s the other part of what we mean by diversification: it’s something that we do within asset classes, just as we do across them.

THAT’s why responsible financial advisors–even when it hurts, and even when it would be far easier in some ways to do otherwise–have for seven years somewhat apologetically kept their beloved clients in portfolios that diversify away the risk of these 20% moves in a single stock. These apologetic portfolios turned an S&P 500 loss of 37% in 2008 into a loss of something more like 10-20%, and it’s these apologetic portfolios that will help keep investors from failing fast or really, really fast when the next crash comes.

Fear of missing out is real, but it’s a small price to pay for confidence, and an even smaller price to pay to sleep well at night when others are losing their minds. So I’ll keep my current house, which never keeps me from important things like good food, experiences with my friends and family, and the freedom to give generously, and I’d encourage you to keep your diversified portfolio, even when fixed income stinks, and even when you see certain individual stocks go up like crazy. Doing so will never keep you from the stuff that really matters, and it will help you miss out on stuff that, quite frankly, you need to avoid like the plague.

Stay safe out there!