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The past few weeks have been a roller coaster ride as investors try to weigh the financial impact of the escalating tariff fight between the U.S. and China, with President Trump admitting investors may experience ‘a little pain‘ and China promising to fight U.S. tariffs ‘to the end.’

We have no control over the risk caused by world events and the impact they may have on our portfolios, but there are risks we can avoid to improve our financial security.

As we’ve said before, the most important determinant of return in your portfolio is how much you decide to invest in stocks.  The more you have invested in higher-risk stocks vs. bonds and cash, the higher your returns will be over a long-term horizon.  After making the decision to invest in stocks, many people add additional risk to their portfolios that provides little to no reward.

One example is home-country bias.  All around the world, investors tend to hold more stocks based in their home country than those outside their borders.  This home-country bias is probably due to our comfort with the familiar, but the result is a portfolio that moves in sync with the economic environment of the portfolio holder.  If you hold only U.S. companies in your portfolio and the U.S. goes through a recession you may lose your job – and your retirement savings will likely sink in value along with your employment opportunities.

Others invest heavily in the company where they work because they feel it’s a great business, are confident they’ll know when things begin to change, and believe they’ll get out of the stock before it drops in value.  Many employees at great companies like GE and P&G, and others at companies we later learned were not-so-great, like Enron, have been surprised by drops in their employer’s stock price.   Many P&G employees still remember retirees who had to delay their planned retirement when their P&G shares fell by 48% in the first three months of 2000.  

The last temptation is to own only the ‘best’ stocks.  Whether we use their products, they’re a familiar brand or someone has written about their amazing business plan – there’s a temptation to concentrate a stock portfolio among companies we’ve come to believe will out-perform all others.  To be fair, concentrating a portfolio in only a few companies can provide outstanding returns sometimes.  We’ve all heard about a friend or relative who invested in a company that doubled or tripled in value, but they rarely share the story when one of their holdings goes under.  The difficulty is knowing which path you’re on when you first purchase the stock.

A recent paper published in the Journal of Financial Economics outlined how difficult picking the best stocks can be.  Using the CRSP database returns for 25,782 distinct stocks that existed from July 1926 to December 2015, it was shown that the best-performing 4% of listed stocks accounted for the entire lifetime wealth creation of the U.S. stock market over the 89-year period.  Put another way, 96% of the stocks you may have chosen to buy would not have provided you with any of the wealth created by stocks over that 89-year period.

A concentrated portfolio has a greater chance of missing out on the top 4% winners, while a diversified portfolio will own the top 4% as well as the losers.  You can only lose 100% of the value of a bad investment, while the stock of a wildly successful company can appreciate thousands of percentage points, so owning more of the market, rather than less, works to your long-term benefit.

The world exposes us to some risks we can’t avoid, but you can do your part to avoid others.  TAAG’s investment philosophy – diversifying your stock holdings among developed and emerging countries, large, and small but growing companies – gives you the greatest opportunity to participate in long-term positive stock returns, without taking unnecessary risk.