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09 June 2024

The Middle of the Fairway


June 9, 2024

This weekend, Team Target Rock is competing in the Member-Guest tournament at Springdale Golf Club, the site where our partnership took root in 2021.

As we’ve written before, golf has many parallels to our work as wealth advisors. This weekend, we’re especially cognizant of one virtue – keeping the ball in the middle of the fairway – both on the golf course and in our investment portfolios.

We observe that people often exhibit one of two extremes: hiding out in cash, or concentrating their bets in a few well-known, high-risk stocks. We believe the best risk-adjusted returns are harvested through consistent diversification.

The safety blanket of money markets

Let’s turn the clock back to January 1, 2023. We had just endured one of the most brutal years in recent memory for the diversified investor, with both stock and bond benchmarks down over 20% in 2022. Over the course of the year the Fed jacked up interest rates, reviving money market funds and high-yield savings accounts with an enticing yield for the first time since 2008.

At the beginning of 2023, it seemed very appealing for shell-shocked investors to pile into cash and earn a risk-free yield of 5%.

Since then, a standard 60/40 stock and bond portfolio has outperformed money markets 21.8% to 7.4%. Of course, these two portfolios differ in the amount of risk the investor assumes.

If the purpose of the money is to be spent in the next year or two, the money market or high-yield savings account is appropriate. For any longer time horizon, we’d argue that the extra bit of risk in this diversified portfolio is not only sensible, but necessary to compound wealth and outpace inflation.

Over a longer period, the benefit of the diversified portfolio becomes clearer:

The intoxicating allure of the hot stocks

We came across an interesting stat this week – Nvidia has accounted for a third of the S&P 500’s entire return so far this year.

You might have seen our thoughts on this juggernaut a few weeks ago – where we dubbed it a “quality company” – and one worth holding in sensible proportions.

This weekend, we met someone on the driving range who bet a goodly portion of their IRA in NVDA a few years ago (good call!) and is wondering what to do from here. Sell and lock in gains, or keep riding?

A few points about hot stocks like Nvidia:

  • It’s hard to predict which stocks are going to deliver massive returns in a short period of time. When it works out, people brag about their genius on the driving range. But they’ll keep mum when their bold bets burn them. The information that reaches our ears is biased. It leads to misplaced FOMO, which can derail our long-term investment strategies if we succumb to it.
  • Since it’s hard to predict which stocks will carry the portfolio in any given year, a better approach is to hold a much broader basket of them. This way, you’ll have a higher chance of holding the winners.
  • The recent run-up of a handful of the largest companies in the S&P 500 Index has led us to a point of historic concentration of risk in that popular benchmark, where the top ten companies (2% of them by count) make up over 33% of the value.
  • The S&P 500 does not a complete portfolio make. It’s only so diversified in and of itself.

Keeping the ball in the middle of the fairway

Our approach to investment management follows a systematic process to limit the effects of emotional biases and harness the power of diversification – often touted as “the only free lunch in investing”.

The trouble – and why we have jobs – is that true diversification can mean something different for everyone.

We’re here to help you take inventory of your wealth and dial in your strategy to limit the slices and hooks and give you a better chance of hitting the fairway.

And we promise we are better at that than golf. Ask us how we did in the tournament, which will be over by the time this message hits your inbox.