Are You Really Diversified? If Not It Can Cost You

August 2023 ISSUE August 1, 2023
Investments Investment Strategy
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“Only when the tide goes out do you discover who’s been swimming naked.” – Warren Buffett

In recent years, we’ve noticed an alarming trend among doctors. More are contracting a case of what we’re dubbing “investment amnesia,” often brought on by FOMO, or the fear of missing out on above-average investment returns. This affliction tends to rear its head during periods of market optimism. Symptoms include buying stocks based on most recent performance (known as recency bias), day trading, and holding concentrated stock positions.

One common manifestation of this phenomenon is an overconcentration in U.S. Large Cap stocks, such as Amazon, Apple, Google, Tesla, Netflix, and Facebook. Especially prominent are the U.S. Large Cap Growth stocks, which have enjoyed an extraordinary performance run over the last decade. For example, the Russell 1000 Growth Index, which gauges the performance of U.S. Large Growth companies, has generated annual returns of nearly 15% over the last 10 years ending May 31, 2023. Compare this to the 7.75% average annual return for stocks over the same time period, and you can see why the shiny appeal is so hard to resist.

Unfortunately, this “recency bias” has caused many doctors to overload their portfolios with U.S. Large Cap Growth stocks. Worse still, many doctors are blissfully unaware they’ve done this. For example, while certain mutual funds are titled as “U.S. Stocks” it can often be overweighted with Large Cap companies that represent only 40% of the global economy. And it’s not uncommon for dentists, aiming to diversify, to invest in multiple mutual funds only to discover these funds are all heavily invested in the same few stocks!

This illusion of diversification can be costly! Investment trends don’t last forever. When the favorable trend for large cap growth stocks changes, doctors who are overconcentrated in that sector could suffer big losses! That could turn their 401(k) into a 201(k), with the missing portion gone without a trace!

What Can You Do?

First, consult with your investment advisor to determine if you are truly diversified. Then, explore other asset classes with a proven long-term track record, like value stocks and small cap stocks, to help you achieve that goal.

Think of a value stock as a hidden gem at a garage sale. It’s a company’s stock that’s undervalued on the stock market for various reasons. Savvy investors, such as Warren Buffet, who spot these bargains wait patiently for the market to recognize the stock’s true worth, ultimately pushing its price up and turning a tidy profit. While the more recognizable growth stocks have enjoyed a run of outperformance during recent years, over the long term that’s not the case. On average, value stocks have outperformed growth stocks in the U.S. market by 4.1% annually since 1927.

Also, the Russell 1000, comprising the largest 1,000 companies in the U.S. stock market, has provided an impressive 11.77% annualized return over the 10-year period ending May 31, 2023. However, lesser known small company stocks have outperformed these better known larger stocks, as witnessed by the Fama-French U.S. Small Value Research Index’s 14.61% annualized return over the same time period. Furthermore, the Fama-French Index would have yielded triple the portfolio value over the longer term since 1979. It’s clear there’s more to the stock market than just larger companies, so don’t ignore these other investment options.

So, consult with your financial advisor to make sure you’re properly diversified to improve returns and reduce your risk. For more information on McGill and Lyon Dental Advisors’ Tax, Business, and Financial Planning Program, which includes a complimentary investment portfolio review to ensure true diversification, email or call 704.424.9780.

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