While portfolio balance and diversification are vital investment goals, you shouldn’t forget that simplicity is too.
Most investment guides stress the benefits of balance and diversification in an investment portfolio. All too many overlook the virtue of simplicity—of reaching your investment goals by the most direct route. If you ignore simplicity, you’re liable to wind up ‘reaching for solutions’ to investment problems. This is a little like ‘reaching for yield’—choosing the highest yield, even if it brings unwanted risk. Reaching for solutions is riskier, because it can lead you further astray.
Here are some of the consequences of disregarding simplicity in your investments.
■ Over-diversification. We’ve often pointed out that too many stocks are as much a portfolio error as too few. A goal of 20 is right for most of us.
Allow the total to run much higher and you may wind up with a portfolio crammed full of neglected investments—so many that you can’t even name or remember them all. Inevitably this leaves you with over-representation in some areas and under-representation in others. It also leads you to fritter away priceless time for which you can surely find better use.
■ Buying glamour stocks and conversation pieces. A boom comes along every few years, in marijuana stocks, bitcoin or whatever—and we all feel an urge to get in on it. When you give in to that urge, you give up a simple goal: earning a worthwhile return on your investments by tapping into the growth that takes place naturally, over time, in high-quality companies that operate near the core of the economy.
Instead, you hope for a windfall, a more complex and pitfall-riddled task. To profit from a boom, you need in most cases to give up security and take on extra risk. Do that often enough and it’s bound to backfire on you.
■ Focusing on trends and ignoring finances. This past decade has seen the rise of ride-sharing technology companies Lyft and Uber. Since these companies went public in 2019, investors who got in at the initial price offerings (IPO) have reason to regret their move, as both are now trading below their IPO price—in the case of Lyft, more than 50-per-cent below the original offering price.
These performances are not too surprising, since both companies remain unprofitable and cash flow negative. You need to weigh the impact of economic, social and technological trends when choosing investments, of course. But a far more direct route to profit is to invest in profitable, well-managed companies, because they are the ones most likely to profit from new trends.
■ Loading up on hybrid investments and innovations. If you could buy one security, your best choice might be a convertible, retractable, floating-rate participating preferred, or some other investment innovation that combines every feature you could ever want in a single package. But you can secure those same features by buying a variety of securities, each with its own special advantages.
This goes double for exotic tax shelters. Each one is different, but many are designed so that the insiders can’t lose, and the outsiders need extraordinary luck plus tax deductions just to break even. Investment hybrids and innovations with a short lifespan, such as stock options, are generally even worse. The vast majority of non-professionals lose money in options.
Mind you, a tax shelter partnership, convertible or some other hybrid or innovation may be right for you at times; you might even want to buy a stock option or futures contract a few times in a decade. But you still need to think of simplicity as a portfolio virtue. Most of the time, it means you’re better off with most of your money in good old stocks, bonds and cash.
■ Reaching for security. Many investment innovations lure you in with promises of security and guarantees against loss. In investing, as in life generally, it’s impossible to hedge against every possibility, or insure yourself against every risk. It’s in dire circumstances where you need the promises and guarantees, but that’s when they are likely to fall short.
This is an edited version of an article that was originally published for subscribers in the October 2, 2020 issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.
The Investment Reporter, MPL Communications Inc.
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