What’s the secret to long-term success in investing? Many people think it is anticipating important trends before anyone else, or picking that one big, winning idea. Others often “follow their gut,” relying on common sense and intuition to make their “buy-sell” decisions.
Following these methods usually makes an investor get it backwards—they buy and sell at the wrong times, they let fear and greed overrule discipline, and they build imbalanced portfolios that don’t withstand the test of time. Their portfolios are too conservative or too aggressive; have too few stocks or aren’t diversified; or lack consistency, as investors become frustrated when markets inevitably work against them.
Successful investing at its core is not fancy or particularly clever. It starts with a clearly stated discipline and purpose¹, set in the context of an investor’s current and future goals (their risk profile). Alongside any proper investment discipline run two key principles:
- DIVERSIFICATION, which means spreading risk and return across different investment opportunities within a portfolio
- REBALANCING, which means regularly trimming a portfolio’s high-flyers and adding to its laggards.
At first glance, these two principles may seem confusing: why pursue investment opportunities that might not be working right now? And why on earth would you trim the portfolio’s clear winners and add to the obvious laggards? The answer rests on a key concept that we have observed many times in the past: winners don’t tend to win forever, losers don’t tend to lose forever, and you can’t reliably predict when they will swap position.It’s akin to predicting where lightening will strike next during a storm. Using a baseball analogy, the “singles and doubles” of a diversified/rebalanced approach tends to add up over time, whereas you are not likely to even get on base trying to time the market’s gyrations. Of course, in those cases, the homeruns end up being elusive.²
How CornerCap Defines Diversification
- Different investment types (e.g., stocks, bonds, commodities, real estate), which behave differently as the global economy surges, falls or chugs along
- Different regions (US, Europe, Asia, or emerging markets like Russia or Mexico)
- Different sizes (large stocks such as Alphabet, JP Morgan, or Boeing; or small stocks, which most people don’t recognize but can provide excellent long-term growth)
- Different investment styles (Value, Growth, Momentum, Low Volatility, etc.)
In our experience, each of these dimensions should have something working well at any time, while each will also have something lagging. Some should do well when the economy is booming; others should do well when recession hits; and still others will do best when other forces (inflation, steady growth, etc.) are at work.
Rolling It All Together
Diversification and rebalancing are vital to success because they help keep the portfolio’s dynamics aligned with the discipline and original purpose behind the portfolio.
Once we assess an investor’s risk profile, we will assign weightings to these various dimensions to help an investor achieve their financial goals across uncertain and unpredictable market environments. The mix of investment assets aggregates into an expected risk/return profile, customized to an investor’s stage of life.
Then, by regular rebalancing, we strive to maintain that profile as the various investment components ebb and flow.
We believe that discipline, diversification, and regular rebalancing—not guesswork, big bets, or gut reactions—will help you develop and follow an investment strategy that takes you where you want to go.
² This is not to be confused with the theory behind tilting, which we will discuss in our blog post tilted “Tilting in Diversified Portfolios”.