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How a Diversified Portfolio Works

2021’s Gamestop phenomenon has showcased that there will always be a new investing trend that returns-chasers are on the lookout for. Recently, we’ve seen a number of unique investments have their moment in the spotlight. However, it’s also clear that, regardless of how popular these investment tactics may be, they’re incredibly short-lived – especially in the framework of a long-term investment strategy. 

Still, as financial advisors, we often get questions from clients, family, and friends about whatever investment idea has hit the headlines recently. We wanted to take a moment to dig into the reasoning behind this phenomenon, and why sticking with a diversified, consistent portfolio is more likely to bring results (even if it’s not always exciting!). 

Fear of Missing Out

It’s understandable that you might feel pulled to jump on the latest investing bandwagon. It’s part of our psychology to want to be part of a group and, more specifically, to be part of the “winning” team. Let’s take a look at the most recent GameStop phenomenon that took Wall Street by storm. 

GameStop sales and profits haven’t been stellar since the pandemic with COVID-related restrictions detering in-person buyers and the more overarching trend towards digital gaming and, therefore, purchasing. 

That was until the r/WallStreetBets (a subreddit dedicated to investing), and other individual investors, set their sights on raising the value of the stock. 

At this time last year GameStop stock traded for about $4 a share. To kick off 2021, its share rested at about $17. At its peak a few weeks ago, it hit its highest numbers yet at $483 a share. 

When Wall Street hedge fund managers started shorting GameStop stock in hopes of making a profit, individual investors took advantage. “Shorting” stock requires the buyer to buy back the stock – regardless of whether it depreciates enough to make a profit or not. When r/WallStreetBets investors started buying up GameStop stock like crazy, the price inevitably rose. This pushed hedge fund managers to buy back their shares at an inflated price to cut their losses. In the end, some investors “won” while others “lost” depending on what side of the deal they were on. 

Then, when the news about GameStop stock’s value increase went viral, many other investors felt motivated to get in with the “winning team” by buying the company’s stock. Of course, the price was inflated far beyond its actual value, and to make any kind of profit on that purchase would require active trading (and it’s risky!). Still, the inevitable herd mentality often kicks in, and it gives investors a bad case of Fear of Missing Out. 

What to Know About “Trendy” Investments

GameStop is a prime example of why trendy investments are inherently dangerous for your portfolio’s safety. Engaging in active trading, or jumping on an investment bandwagon when it’s all over the news, is almost never a good idea. Why? 

Because by the time you hear about an up and coming investment that’s giving investors “big wins” – it’s likely already too late to join the party. Buying when an investment is popular means you’re buying high, and this often puts investors in a position to lose money when whatever the trendy investment inevitably loses value after the craze dies down.  

It’s also important to remember that, in many cases, you are only hearing the “wins” from a particular investment trend. Investors who experienced a major loss, or who had to hustle to break even, don’t make the news. In other words – it may feel tempting to join the winning team, but be aware that the full truth is likely not making its way into reports you’re reading.

Predictability is Boring – But Key to Success

The truth is that your portfolio shouldn’t be the source of excitement in your life. Unless, of course, you get excited about seeing slow and steady growth that consistent saving and a diversified portfolio brings. Most people are investing for the long game. They’re growing their nest egg for retirement, or to leave a legacy that impacts generations to come. 

There’s no free lunch when it comes to growing your wealth. It takes dedication and, frankly, it’s often boring. That’s how it should be! “Boring” investments get the job done and earn a predictable rate of return over time to help you grow your savings. 

Let’s take a look at the above chart. Over a 20 year period, a diversified portfolio may *feel* like it comes with losses and minimal gains. However, you can see here that, when compared to the S&P 500, a diversified portfolio still earns an impressive total return. 

Remember – even though focusing on a diverse portfolio, and a consistent, long-term strategy may not feel like you’re “winning” as much as investors who make the headlines, you’re setting yourself up for long term success.