Being a Contrarian in Today's Investment WorldSubmitted by Latitudes Financial Strategies on April 18th, 2017
Optimism, in the long run, is a powerful investment tool. The act of investing requires a certain amount of hope, I mean why would you commit dollars to an investment in the first place if you didn't think that you would, eventually, successfully end up with more money? Optimism, however, shouldn't work in a vacuum: wisdom is a powerful investment tool also and the ability to recognize when the investing crowd is following each other blindly is also a powerful bit of knowledge to have in hand.
After 32 years of giving professional investment advice (by professional I mean that people continually pay to hear my opinion and follow my advice) and over 50 years as an investor (I started when I was 10), I can tell you that basic fundamental piece of investment advice, "Buy low, sell high" is frequently ignored and even ridiculed. I find that there is a certain middle school cafeteria mentality to investing: let's all do what the cool kids are doing and gang up on the nerds is you don't share our worldview." If the world has taught us anything, it is that nerds can sometimes win.
Ask your nearest tech billionaire.
So what brought all this on? I've been reading some articles on the crowds of people who are jumping into a popular investment strategy with no further investment strategy than, "Well, its what they recommend." On my desk I keep a book written in 1841 called Extraordinary Popular Delusions and The Madness of Crowds by Charles McKay and if you are an investor I believe it is imperative that you or your advisor have an intimate knowledge of this book, it is as relevant today as it was 176 years ago. Mackay describes financial bubbles like Tulipbulbmania, and the South Sea Bubble, times when mobs of amateur investors crowded into trades that were fundamentally overvalued and then panicked out of them when the crowd sentiment turned. Greed and fear are still alive and well and knowing a little about market psychology is critical to the person who is serious
The relevancy? Just about every new client I welcome to my firm is investing about the same as everyone else. Many people who think they are diversified are actually very concentrated in the same size companies, same countries, and even the same few stocks! The investment backdrop of 35 years of falling interest rates has created "common knowledge" that investing in stocks is a reasonable alternative to bank deposits. The election has created "common knowledge" that we will get tax reform and Americans should invest only in America.
Common knowledge is my mortal enemy, market tops often form when everyone is thinking and investing the same. Market crashes typically occur when changing market sentiment causes everyone to change their mind at once. In this age of instantaneous communications these shifts in sentiment can occur at startling speeds.
Do I know the future, am I predicting a crash? NO! I'm talking about the fundamentals of investing, I'm reminding you that diversification is one of the most important foundations of a good investment strategy, that looking for opportunities to escape being trampled by the herd is a concept that seems to be forgotten. Modern portfolio theory, a pillar of the current science of investing, suggests that diversifying your holdings is the best way to reduce some of the risks that are inherent when you invest.
Look, I like a good steak now and then but if I was forced to eat one everyday and every meal, I'd worry that my body would not react well to my lack of diverse diet. I know I'm stretching the metaphor here, but your portfolio should have a balanced diet too. Too much of anything, as our Mom's taught us, is a bad thing.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
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