Throughout life, there’s a fine line between being confident and having hubris. Often, we tend to innately gravitate towards the latter. Look no further than the famous study by Ola Svenson, “Are we all less risky and more skillful than our fellow drivers?”, in which an overwhelming majority of respondents rated themselves better drivers than the average motorist.
Anyone who has a basic grasp of statistics (or has been on a busy highway) knows this isn’t the case. Unfortunately, this innate tendency – known in academic circles as the overconfidence effect – also leaks into investing, and it can be just as dangerous.
This bias often rears its ugly head when your investments are doing well. Often, you’ll attribute it to your own skills,and overestimate your ability to pick more “winners.” This becomes dangerous when you think you can beat the market (when almost no one can), or when you make a concentrated bet on one investment.
Choosing an asset class can be akin to gambling, because it’s impossible to predict with certainty which class will be a winner. The performance of any given asset class can have drastic periodic changes. For instance, from 2004 to 2007, international equities were the highest performing asset class, with double-digit returns year after year. The year after, this class became the worst performer, with -43 percent returns.
Ultimately, what can threaten the growth of a well-diversified portfolio over time is not market fluctuation, but the tendency to shift strategy by letting emotion overwhelm logic. The wise investor realizes that potential returns may be large, but the concentrated risk of one asset class or investment is not the best way to invest. Utilizing a well-diversified portfolio, on the other hand, can reduce risk, and in many cases can provide the same return. You may miss a portion of the gains for one period, but you’ll also avoid the heartbreak of a losing class.
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LexION Capital creates a diversified portfolio based on your risk tolerance, and your goals and needs are always our highest priority. As a client, your savings are invested in a unique, diversified investment solution that can minimize risk and maximize return. If you’d like to learn more, don’t hesitate to contact us today.