It can be costly to not be diversified. An example is the massive drop in Boeing stock prices after 737 MAX crashes and cancelled orders.
- With two tragic plane crashes within 5 months of each other, Boeing’s share price went down 14.8%, from $440 USD to $375.41 USD in early March 2019. This situation perfectly demonstrates why diversification is so important for investors. Any great company, even one operating in a duopoly, can face unforeseeable events and see its stock price plummet suddenly.
- Growth-oriented assets have so far performed well in 2019, but this strong short-term performance shouldn’t have undue influence on your investment plan. As we told you not to panic in December, do not get over-excited now; just stick to your plan! After all, the key to successful long-term investing comes from being systematic about your way of investing. Market timing can be a costly exercise when not done correctly, and the odds are low for getting it right.
Our thoughts go to the families affected by the two recent plane crashes. This article is solely to draw investment lessons that can illustrate how quickly and unexpectedly even a large, reputable company’s share price can drop, and how that can affect an improperly-diversified portfolio.
Boeing offers a lesson on diversification
On 10 March, the Boeing 737 MAX aircraft flown by Ethiopian Airlines crashed near Addis Ababa, killing all 157 people on board. This comes less than 5 months since another Boeing 737 MAX aircraft plunged into the waters off of Indonesia. As investigators look to uncover root causes of these accidents, a growing number of aviation authorities around the world are grounding Boeing’s 737 MAX aircrafts. The debacle has sent Boeing’s share price down 14.8%, from $440 USD to $375.41 USD between 1 March and 12 March.
This example of a highly reputable company’s stock price plummeting with its planes goes to show the vagaries inherent with investing in single-name securities. Unexpected events can severely impact the value of a particular investment, negatively or positively. It’s not rare, and it’s unpredictable: for example, it happened last year to Facebook with Cambridge Analytica. The lesson investors can draw here is to have a diversified portfolio so they can sleep better not worrying about potential events within a company, such as plane crashes, a privacy scandal, a CEO affair, or about external impacts on a company, such as a sharp increase in oil prices.
Using what’s going on with Boeing to illustrate the importance of diversification, let’s compare the daily percentage change in the share price of Boeing against VTI, which is a Vanguard ETF that tracks the CRSP US Total Stock Market Index. The latter is a very broad representation of the universe of investable stocks in the US, and is made up of more than 3,500 companies. The benefit of diversification is very clear here: in Figure 1, we can observe that the swings in the Boeing stock price (orange line) can be as wide as +/- 7% per day. This volatility is significantly wider than that of the tracking ETF (blue line).
Figure 1 – Boeing (NYSE:BA) versus Vanguard Total Stock Market ETF (NYSEARCA:VTI)
Beyond smoothing out price swings, diversification also mitigates the problem of being exposed to event risks, such as companies being delisted or going bankrupt. It is simply too onerous and complex for an investor to track and analyse a large number of single-name securities to find winners and avoid losers.
Diversification is also not about simply having a large number of securities in a portfolio. Things become significantly more interesting when an investor starts including different types of asset classes into their portfolios. An effectively diversified portfolio would be invested across geographies, and strikes a good balance of allocations to growth assets (e.g. technology stocks, etc) and protective assets (e.g. government bonds, high-grade corporate bonds, gold, etc).
The bears are defiant
Defying all negative expectations, growth-oriented assets have reversed their doldrums in late-2018, and performed admirably in the first quarter of 2019. Small-cap growth stocks (the riskier tranche of the US stock markets) was pronounced dead at one point in late 2018. The sector went on to outperform with a YtD return of +19.2% in 2019. In the technology sector, regulatory pressure on companies remain an issue and could possibly re-escalate into the 2020 US general election when opportunistic Presidential candidates capitalise on public sentiments to regulate or break up big tech firms. The irony? US technology sector (as proxied by the US technology ETF, XLK) delivered +16.8% in YtD return anyway.
Due to a more accommodative stance from major central banks (US Federal Reserve, European Central Bank, Reserve Bank of Australia and so on), interest rate-sensitive assets such as the Real Estate Investment Trusts have rebounded well. In particular, real estate investment trusts (REITs) in the US, Asia ex-Japan region, and Singapore have all performed well with YtD returns of +16.1%, +9.4%, and +8.5%, respectively.
So far in 2019, growth-oriented assets (dark blue bars in Figure 2), outperform protective assets (light blue). Consumer staples, with its +8.5% YtD return, is the only protective asset on our radar that have performed comparably well. Other protective assets such as Singapore Government Bonds have underperformed with a YtD negative return of -2.7%. Having said that, we think it’s important for investors to always maintain a sufficient amount of protective assets in their portfolios, regardless of how they perform in the near term.
Figure 2 – Year-to-Date Asset Class Performance
Source: StashAway, Bloomberg
Stick to your investment plan
It’s important to keep in mind that we should not allow short-term performance, whether it’s up or down, to influence our long-term investment plan. A good investment plan helps you set the right risk levels to be compatible with your life goals and personal risk tolerance. Your plan should be prepared to roll with the natural ups and downs of the markets. A good investment plan also effectively diversifies a portfolio to strategically avoid concentration risk in any one security or asset class.
Unlike traditional financial advisors and other robo-advisors, the internal algorithms build and manage global, customized portfolios of highly diversified, low-cost ETFs across asset-classes, while putting an emphasis on risk management by incorporating deep analysis of economic cycles in order to navigate its ups and downs and maximize long-term returns.