Being diversified and having an appropriate asset allocation is boring. That's what many people think, especially after the stock market has been on a tear for a while. A year like we've had so far helps accentuate this sentiment. When you're diversified, you don't have a large amount of your portfolio invested in the so-called FANG stocks (Facebook, Amazon, Netflix, and Google) that have done so well this year. You might have a small amount invested in them, so your portfolio does benefit, but you're not seeing the outsized returns that can come from investing heavily in a few stocks that happen to be doing well at the time. But you're not in danger of being bitten either. That's the tradeoff and it can be a tough pill to swallow sometimes.
It is important to remind ourselves of this tradeoff and recalling the lessons of history helps in this regard. Last Friday, September 15th, marked an important day in the history of the markets as the day in 2008 when Lehman Brothers failed. The 158-year-old investment bank was doing extremely well but, in hindsight, had massively overleveraged itself in the subprime mortgage market. As that market collapsed, Lehman found itself without a chair when the music stopped. Going into the weekend of the 12th the future of the bank was truly uncertain. Many market commentators and investors believed that someone somewhere, another company, or even the government, would swoop in to save the firm. But by late Sunday night everyone was shocked to learn that Lehman was doomed to bankruptcy. That Monday the stock market was down a ton and experienced massive volatility during the following days. Then, as we're all aware, an already precarious market and economic environment turned further south and the Great Recession ensued.
Why is the history of Lehman Brothers important to remember? Wouldn't we rather forget nasty market conditions and instead recall the market's recent upsurge? Of course! It's human nature to want to accentuate the positive, but remember that very little about investing is intuitive. It's hard to take the long view as parts of the market, or even individual stocks, race past you as they perform well for a time. And it can be harder still during times of market disruption, as with Lehman Brothers. So, we must remind ourselves that we're in this for the long run and that there will always be someone or something outperforming you in the short-term. What matters instead is performance over the long-term, and this is where being diversified and having an appropriate asset allocation show their worth.
The following article from Dimensional Funds illustrates this well (emphasis mine), especially as we near the 10-year anniversary of the market highs before the onset of the Great Recession...