Mr. Mike Sharples, who serves on our board, recently wrote an intriguing blog that uses a basketball analogy to explain the stock indexes, investment risk, while providing some valuable insights about the future. I enjoy investing and watching basketball (I am too old and short to play), so I wanted to share it with you. Thanks Mike for giving us permission to do so.
A stock market index is not an accurate measure of success for a diversified portfolio. The indexes we talk about the most, the Dow Jones Industrial Average (DJIA, or “Dow”), and the “S&P 500” (an index of approximately 500 companies compiled by Standard and Poors) are “market weighted” averages. That essentially means, the bigger the company (measured in terms of market capitalization) the more the company can influence the index.
What does that mean for your portfolio? Imagine two different basketball teams of five players, it is the season after all. The Championship team from last year is used as the “index” that all the other teams measure themselves against. The Champion Index team has three players that are 7 feet tall, one player that’s 6 feet tall, and one player that’s 5 feet tall. Your team has one player that’s 7 feet tall, one player that’s 6 feet tall, and three players that are 5 feet tall. The way the Dow and the S&P500 measure performance, a 7-foot player’s scoring counts for more toward influencing the index than a 5-foot player’s scoring. But as a coach you know scoring the most points during the game is how you win the game, it doesn’t matter if it was your 7-foot player or your 5-foot player who scored. You also recognize that your team will most likely never look exactly like the Championship Index team.
The other decision you may have made when you recruited players to your team is that you wanted a defensive expert who may not be very good at scoring. Your strategy was to win some games on defense rather than just offense, and to avoid being “blown-out”. You might call this strategy “winning by not losing”. In the end you know there are lots of basketball teams in this country with very few of them looking exactly like the Championship Index team. What matters most to you and your fans (family) is winning games.
Risk in the stock market is measured as fluctuation around the average, for example how much does a stock go up AND down over the course of the last 12 months. The more risk, the more an investment “could” fluctuate in value (based on the past performance). Continuing with the basketball analogy, a “streaky player” is a “risky” player. When they’re “hot” they can’t seem to miss a shot and when they’re not, they can’t seem to make a basket at all and they’re playing terrible defense. How many “streaky-players” would you like on your team?
As we build our financial plans which includes a portfolio of various investments, we tend to think of risk more as permanent loss, not just fluctuation. In terms of basketball, winning the game is more important than whether you won by 1 point or 20 points. Progress toward your financial goal is the most important part of measuring your success. The other thing to remember is that as a coach you can change your line up to better adapt to the environment you’re playing in and how your players are performing. Your streak shooter may be on a roll so you leave him in until he cools off, then you substitute your defensive expert to win by not losing. What matters most to you and your fans (family) is progress toward your goals and winning games.
I believe, after reading many investment and analyst outlooks for 2018, we’re going to want a few key players in your portfolio for the 2018 season. Virtually all the recommendations I’ve read have made the case for global growth improving in 2018 and therefore international stocks have a good outlook. The 2018 tax cut is predicted by the same publications to help small and midcap US stocks. Interest rates are expected to move higher but not at a rapid pace so there may be some downward pricing pressure on bonds with their performance projected to trail stocks in general. As the interest rates rise and the financial regulations ease in the predicted expanding US economy for 2018, financial stocks may do well in 2018. Lastly, I read a great deal about the potential growth in a variety of areas through the combination of developments in AI (Artificial Intelligence), Robotics, Big Data diagnostics, Blockchain technology, genetic therapies (via CRISPR), and API (Application Programming Interface). These developments are both exciting and sometimes a bit unnerving but there is certainly plenty of potential growth opportunities for the future. My son (who’s 8) is expecting to ride in his own self driving flying drone one day, I’m pretty sure it will happen, I just don’t know how soon (he keeps asking).
May the New Year be Happy and Prosperous for all!
Mike Sharples CFP®
3710 University Dr., Suite 130
Durham, NC 27707
Direct: (919) 402-1651 / Toll-free: (877) 744-1651
Cell: (919) 257-0209 / Fax: (919) 402-1655
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The opinions voiced in this material are for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
The economic forecasts set forth in may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
Investing in stocks involves risk, including possible loss of principal.
International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors.