Keep calm and diversify

The world might change, but markets not so much

Photo by Adam Nowakowski on Unsplash

Hello,

Welcome to Known Unknowns, a newsletter that is remaining calm and diversifying as the world goes nuts.

The World in Flux

It may surprise you that I think the world is becoming less risky. It may sound crazy, considering we have a few major geopolitical crises (the Mideast, Eastern Europe, and probably Southeast Asia soon). The last week in politics was pretty wild and could lead to some consequential changes, and we are experiencing a major technological shock that will transform markets and our way of life. It’s a lot.

But in many ways, for most people, we’ve never experienced so little downside and disruption from all this turmoil. No matter what happens, the odds are slim most Americans will starve, see violence on their doorstep, or even see their wealth destroyed. If markets go totally haywire, policymakers will do their best to limit downside risk—and they have better tools to do so. You could argue that this is bad because it enables more risk-taking and complacency or props up businesses and politicians who should not be propped up. However, even in the face of elevated uncertainty, the range of actual outcomes we face has narrowed—and markets reflect that.

You could argue, “Well sure, but tail risks have increased.” That may be true; I have no idea what World War III against Iran, China, and Russia would look like. Robots may become our overlords—or just spread lies that sow chaos and destruction. But I see more risks to the upside: a world where knowledge is more evenly dispersed, expertise is at our fingertips, CRISPR technology, and the possibility of prosperity through cooperation and liberal order winning out.

Things have always been risky. Civilization exists on a fault line, and sometimes things rumble, but we’ve become much more resistant to shocks.

But That Doesn’t Mean You Shouldn’t Diversify

Josh Brown alerted me to a survey on Gen Z investors from the CFA Institute. And wow. It is great that Gen Z are investing so young, as it means years to build wealth and more inclusive participation in the economy. They have much higher rates of stock ownership than prior generations. However, they are pretty bad at investing. The most popular asset they own is crypto, which dominates their portfolios. Nineteen percent only own crypto and no other asset. They are also more likely to own individual stocks than mutual funds. Most disturbing of all, many of them had some financial education in school.

It could be that I am wrong. Maybe markets have changed from when I learned that good investing involved going to a mall and buying stock in the stores that were crowded. I suppose financial education has never been great.

The last 20 years of markets were weird. If the market will be dominated by a few big, fast-growing stocks, maybe stock picking is a good idea and diversification is for suckers and fools. If the world is crazy, maybe a currency with no discernible value is a smart investment.

But I doubt it. A decade or two is a short time in finance, and no one market condition lasts forever. This is why good investing, not speculation, involves diversifying as much as you can. It is just efficient. As markets likely enter a more volatile phase from increased concentration, diversification will be more important than ever.

There is nothing wrong with some speculation; I get that it is exciting and can pay off sometimes. To the extent it drives engagement with markets, it has some benefits. But it should have the appropriate role in your portfolio, like gambling in a casino, and should be seen as entertainment rather than your dominant investment strategy.

I suppose a bear market will teach that hard lesson. Gen X and Millennials each came of financial age during bear markets—they are more risk-averse, maybe too much so. But I think we need to take a hard look at financial education, which often fails to include basic risk principles, rather than rely on people losing money and learning the hard way.

Perhaps I am hedging here because I am preaching diversification, even if I think the world is becoming less risky.

Until next time, Pension Geeks!

Allison