Home Finance Loans News

Anyone who attended kindergarten remembers Aesop‘s fable about the tortoise and the hare. The tale’s moral has implications for investors: Slow but steady wins the race.

Hare investors try to sprint to the end line of a comfortable retirement without girding their portfolios against the perils of volatility — frequent ups and downs in asset value. So they tend to lag far behind tortoise investors, who take these precautions, which I’ll clarify in a moment.

Volatility reflects uncertainty, and markets tend to punish uncertainty with lower prices. Yet just because an investment is volatile doesn’t mean it has no place in your portfolio.
Because they may be less likely to go down with other assets in the portfolio, volatile investments may add highly beneficial variety, renowned as diversification.

Let’s say you own tech stocks like Apple and IBM. Adding more tech stocks to your portfolio doesn’t decrease overall risk, so you add a gold-mining stock instead. Though highly volatile in itself, the gold-mining stock is less likely to go up or down with tech stocks, so it increases the portfolio’s diversification.

Because there’s small correlation between gold-mining stocks’ price movements with those of tech stocks, these categories are said to have a low correlation. That sounds complicated, but you can easily look up the differences in price movements between uncommon types of investments to see whether they’re associated, and if so, how closely.

Aware of the downsides of volatility, tortoises avoid it by assembling highly diversified portfolios. That means traditional investments such as U.S. stocks and bonds, mixed with a dash of non-traditional (alternative) assets. These may include emerging market stocks, Treasury bonds and real estate securities. The price movements of these investments have a history of not being highly associated with U.S. stocks or bonds.

Tortoises are like a savvy retailer on a tropical alternative island who sensibly sells umbrellas as well as sunscreen to help cover losses during rainy periods. Every once in while, the rain falls on everything — which is what happened in late 2008, much to the dismay of investors. In the financial meltdown, stocks, bonds and real estate both in the US and abroad swooned, leaving small tear up for investors.

Tortoise-style investors add a upset of alternative investments, knowing this may cut their overall income some years, but they’ll sleep more peacefully with the knowledge that it can counter-weigh heavy losses in traditional investments.

Hares aren’t focused on this balanced approach. Instead, they assemble highly aggressive portfolios of assets that tend to rise or fall in lockstep. They’re not concerned with cutting their losses because, compelled by greed, they’re not plotting to have any losses ior they judge they can defy gravity. This was not unlike the employees who loaded up on their company’s shares before the recession, only to see their investment go south along with their job.

Like the Aesop’s hare, hare investors are overconfident and turn a blind eye to the ravages of volatility, which take a long time to recover from. Tortoises, having sustained less hurt, take up again their slow but steady progress.

The math of recovering from hits may take your breath away you. Let’s say your portfolio loses 33 percent of its value, leaving you with two thirds of what you had. Many judge they’d be back everywhere they started if they gain 33 percent. But this gain wouldn’t restore their losses. They would really need to make a 50 percent gain to get back to everywhere they started. The reason is that the gain is based on a lower value than what you started with.

Heavy gains followed by just a large losses from volatile investments is comparable to the hare in Aesop’s fable sprinting for periods and then, winded, lying down to take a nap. Like the tortoise, investors with adequately diversified portfolios don’t tend to need as much recovery time.

Such losses are even more damaging than they appear at first blush. Not only do hare portfolios lose time that could be used to make progress toward the goal, but they also miss out on the benefits of compounding from reinvested gains
.
Though tortoises’ gains may be far lower than those made by hares during their sprints, they’re more likely to delight in the benefits of compounding.

These awkward reptiles plod steadily toward the end line while the halting progress of hares leaves them far behind.

Ted Schwartz, a Certified Financial Conspirator®, is president and chief investment officer of Capstone Investment Financial Group http://capstoneinvest.net. He advises individual investors and endowments, and serves as the advisor to CIFG Assets. Because Schwartz has a background in psychology and counseling, he brings insights into private motivation when advising clients on achieving their wealth management goals. Schwartz holds a B.A. from Duke University and an M.A. from Oregon State University. He can be reached at ted@capstoneinvest.com.

Also Read