Take a look at last week’s market recap from Joe Gallemore, CIMA® Partner & Director of Investment Management for Argent Bridge Advisors. Watch the video now!
Today we are addressing two general investing concepts, 1) Comparing a portfolio to what you hear on the news and 2) Herd Mentality
When financial media talks about “the market” to what, exactly, are they referring? And is this a fair comparison? The S&P 500 is the most widely used barometer of US stocks. First of all, it pretty much only represents Large Cap US stocks, which is only part of a diversified equity portfolio.
Second, this index is constructed using what’s called market cap-weighting… which simply means the larger the company the greater its representation in the index. Many indexes use this methodology and there are pro’s and con’s to it. But what has ended up happening is that the S&P 500 has narrowed and now disproportionately represents a small subset of stocks. The Top 10 stocks in the S&_ 500 make up 30.3% of the market cap of the index! 7 of those are technology names! So unless your portfolio is super concentrated, which we would never let happen, you should expect your return to be nothing like that of a market cap-weighted index.
There is an old adage in investing, “Diversification is the only free lunch.” And as all of you know, a foundational tenet of our philosophy it to keep your portfolios well diversified. So make sure that when you hear updates on the market, you’re mindful of what exactly it implies. Because it often is not an accurate comparison to your portfolio… and this awareness will do wonders for your sanity.
Next I want to touch on a concept rooted in behavioral finance called Herd Mentality. You may already be familiar with this term, but our spin on this focuses on when you feel compelled to own or participate in investments that are getting the most noise. That’s right we’re talking about FOMO, the fear of missing out.
FOMO is a natural reaction we all have, typically in thinking that there’s safety in numbers… or, in this case, good decision making in numbers. But remember, internet stocks were the craze in the late 90s, until they weren’t… real estate speculation was a can’t miss in the 2000’s, until it was. TSLA seems like a must-own these last 18 months, but you know who doesn’t own it? A large % of institutional investment strategies.
JPM published data last month that showed that, for the S&P 500 index, the higher the ratio of the index price relative to the earnings of all the companies inside it, the lower the returns of the index for the next 5 years. Currently that Price/Earnings ratio for the S&P 500 is 20.3, a little over its long term average. The P/E ratio of those Top 10 stocks we mentioned earlier is 28.6x. The P/E of TSLA= 341x
Also, when experiencing a herd mentality consider that you don’t really know what the person next to you own, and you don’t really know how fleeting a pundit’s level of conviction might be. And rarely do any of these parties share what their exit strategy is.
Acting on FOMO is almost like saying “the herd knows better than my investment plan.” And we just like to remind you to stop and think about which part of that sentence you have more confidence in.