There are three keys to investing that you can use as a framework for thinking about different types of investments and how they fit into a well-diversified portfolio.
Risk: When we invest, we are putting our money at risk to earn a return. Different investments have different levels of risk, and it's important to understand the risk profile of each investment before making a decision. For example, stocks are generally considered riskier than bonds, and bonds carry more risk than cash.
Return: Return refers to the amount of money an investor expects to make. Different investments have different expected returns, and it's important to understand the return potential of each investment before making a decision. For example, stocks generally have a higher potential return than bonds (talking about asset classes, not individual securities).
Diversification: Diversification is the process of spreading your money across different types of investments to reduce risk. When you diversify your portfolio, you're spreading your risk across multiple investments so that if one investment performs poorly, the others can help to make up for it.
For example, if you only invested in stocks and the stock market crashed, your entire portfolio would be at risk. But if you diversify your portfolio with a mix of stocks and bonds, the other investments could help to cushion the blow.
By understanding the risk, return, and diversification potential of different investments, you can make more informed decisions about where to put your money.
In recent years, there has been a trend among younger investors to close their investment accounts due to concerns over inflation. This may seem like a logical decision, as the rising cost of goods and services can make it feel like the value of money is decreasing. However, closing investing accounts over inflation concerns can be a poor decision that could have long-term negative consequences.
Inflation is a normal part of economic cycles and should be expected. It occurs when the overall price level of goods and services in an economy increases. While the current 12-month inflation rate is 6.5%, compared to 8% just a few months ago, remember that the long-term average of inflation for the last 100 years is about 3%.
While it may be uncomfortable to see the prices of everyday items rise, it doesn't necessarily indicate that the economy is headed for a recession or a period of prolonged economic hardship.
Another important thing to consider is that closing an investment account may mean missing out on potential gains. Whether it is the stock market or bond market, many investors have been able to earn substantial returns by keeping their investments for a long period of time. By closing an investment account, you may miss out on the opportunity to earn a return that could offset the effects of inflation. Furthermore, closing an investment account may also mean missing out on the advantages of diversification.
Instead of closing investment accounts over inflation concerns, it may be more beneficial to adjust investment strategies to account for inflation.
Generally speaking, financial advisors would suggest that cash is one of the worst asset classes to hold during rising inflationary periods. And in theory, some sectors generally perform better than others if inflation rises.
For example, companies will pass the rising costs onto consumers when there is high inflation, right? And it stands to reason that if you and I become more selective when we purchase goods and services, we might forgo some luxury items (think jewelry), but we will keep buying basic necessities (like bread and milk). And that explains why the Consumer Staples sector potentially performs better during rising inflationary periods and the Consumer Discretionary sector generally performs worse.
Energy (Oil and Oil Stocks) Interestingly, there is a positive correlation between the price of oil and inflation. In fact, according to the St. Louis Federal Reserve:
The graph shows a strong positive relationship between oil prices and PPI inflation: That is, higher oil prices are associated with higher producer prices and vice versa. Specifically, the correlation between oil prices and the PPI is 0.71. This strong link likely comes from the importance of oil as an input in the production of goods.
Utilities are generally considered defensive as we all still need them (think electricity, heat, gas, etc.) no matter the inflationary environment. And since energy companies pass any higher costs onto us, they are able to maintain their profitability.
Real Estate Sector
The Real Estate sector is often a hedge against inflation too. Consider the largest component of the sector – Real Estate Investment Trusts. REITs own and operate income-producing real estate, and property prices and rental income tend to rise when inflation rises. Further, REITs are required to pay out at least 90% of their net earnings to shareholders annually.
Want more proof of the importance of asset allocation and diversification in one's portfolio returns? Consider the performance of the sectors just mentioned last year:
|S&P 500 Sector||2022|
Notice a pattern? Again, those variations are the epitome of sector rotation, and the numbers empirically identify the importance of asset allocation and diversification for all investors.
But last year's sector performance might suggest that if inflation does indeed remain high in 2023, last year's beaten-down sectors might be worth another look.
Technology addiction and cancel culture are concerns that have become increasingly prevalent among younger investors. Technology addiction refers to the excessive use of technology, such as smartphones and social media, that can lead to negative consequences such as decreased mental health and productivity. Cancel culture refers to the phenomenon of individuals or groups being "cancelled," or shunned and boycotted, for expressing opinions or taking actions that are deemed unacceptable by a particular group or community. Both concerns can potentially cause significant harm to younger investors, individually and collectively.
Technology addiction can be a significant problem, especially for younger investors, as they are the first generation to grow up with widespread access to the internet and smartphones. This constant access to technology can make it difficult for them to disconnect and unplug, leading to various negative consequences. For example, studies have shown that excessive use of social media can lead to increased feelings of anxiety and depression, as well as decreased sleep quality. Furthermore, technology addiction can also lead to decreased productivity, as individuals may find it difficult to focus on tasks and may be easily distracted by notifications and other digital distractions.
Cancel culture is another concern that has become increasingly prevalent. Social media and other digital platforms have made it easy for individuals and groups to call out and shun those with whom they disagree. While cancel culture can be seen as a way to hold individuals and groups accountable for their actions and words, it can also lead to negative consequences. For example, it can lead to self-censorship, as individuals may be afraid to express their opinions or share their thoughts for fear of being "cancelled." Additionally, cancel culture can lead to a lack of diversity in thought and ideas, as individuals may be less willing to engage in meaningful dialogue and debate for fear of being "cancelled."
The concerns of technology addiction and cancel culture are interconnected, as technology has made it easier for individuals and groups to engage in cancel culture. Social media and other digital platforms have made it easy for individuals to call out and shun others for expressing opinions or taking actions that are deemed unacceptable.
To address these concerns, it is important to manage your technology use and engage in meaningful dialogue and debate. This can include setting limits on technology use, such as turning off notifications and setting aside time to disconnect and unplug. Additionally, it is important to engage in meaningful dialogue and debate, even when there may be differences of opinion. This can help to promote diversity of thought and ideas and can also help to prevent the negative consequences of cancel culture.
You might be tempted to think you can predict markets, pick winning stocks and mutual funds, or allocate properly among sectors. But investors of all generations need to understand the risks – not just be able to regurgitate a Twitter story.
Because most of the time, investors don't have the time to perform the proper research and stay up to date on how particular investments, industries, or sectors are performing, that's usually best left to a professional. Furthermore – and maybe most importantly – your investments must fit into your overall financial plan.
Talk to your financial advisor to ensure your financial plan is consistent with your goals and risk profile. Remember, you don't necessarily need what your neighbor thinks is the best investment portfolio in the world – you need your best investment portfolio to reach your goals. Your advisor can help you get there.