Note: Fisher Investments' Editorial Staff doesn't make individual security recommendations. Any stock or security mentioned herein is solely used to illustrate a broader point.
After a dark 2020, it seems investors are growing more optimistic. Contrary to past years, much of the coverage Fisher Investments' analysts have reviewed shows financial pundits appear to be fanning the flames in many cases. Retrospectives on 2020 hype astronomical returns in high-fliers like drug developer Novavax (NVAX, Financial) (up 2,701% in 2020) or Chinese Electric Vehicle start-up Nio (NIO, Financial) (up 1,112%).[i] Others tout fledgling firms with little history as the Next Big Thing. Even the personal finance pages are rife with articles documenting newly minted millionaires whose ticket to riches amounted to a speculative position in a single stock. In Fisher Investments' view, optimism is fine. But getting carried away with it and taking on loads of single-security risk is perilous. Remember: Investing isn't about getting rich quick.
The appeal is straightforward. Those glittering returns tickle investors' greed—perhaps doubly so in a year like 2020, given travel restrictions, stay-at-home orders and business closures. But for them to mean much to portfolio results would require taking a concentrated position—a move Fisher Investments believes vastly increases your portfolio's risk.
Most investors probably have heard that diversification is a critical risk-management tool in investing. There are lots of different forms of this, but the most common is to simply own multiple securities, a move that attempts to mitigate the risk something goes wrong at any single firm you own. In Fisher Investments' experience, that can range from things like a sudden management change to declining competitiveness versus a competitor to accounting issues (among many more). Diversifying your holdings can be a crucial tool in mitigating this single-company risk.
In Fisher Investments' view, though, proper diversification also requires owning a variety of categories of stocks that respond to different drivers—you can't just own a handful of stocks in the same sector and call it diversified. The reason: Most stocks behave like their sector and industry peers. For example, if you only own Technology stocks, your portfolio will likely swing wildly with that sector—faltering when value stocks like Energy or Financials lead, surging when growth-oriented sectors are in favor. Similarly, if you own just one or a few Energy stocks, your portfolio will sway wildly with oil-price swings—to your great detriment over the last six-plus years as oversupplied oil markets drove profits to collapse. Diversifying across multiple airline stocks likely wouldn't have been a huge benefit in 2020.
But even beyond this, when company-specific matters hit a company in one industry hard, there is very often collateral selling in shares of its peers. 2010's huge and disastrous Gulf of Mexico oil spill is one example. It wasn't just the drillers and servicers of the Deepwater Horizon whose stocks suffered—many Energy firms fell for fear of collateral damage.
In Fisher Investments' view, therefore, diversification is not only about mitigating single-company risk. It is also about diversifying across sectors and industries—highlighting those that respond to different drivers. If you are bullish on Energy, for example, own multiple Energy stocks. But also own Technology or some other sector that is less economically sensitive and isn't tied to fossil fuel prices as much.
That can mean owning securities in areas of the market you don't expect to do well. That may seem counterintuitive, but the heart of diversification is humility—knowing you could be wrong. It cuts directly against the logic of making a big bet on a high-flier, but in Fisher Investments' view, it offers you a more probable path to reaching your longer-term goals and objectives.
[i] Source: FactSet, as of 1/5/2021. Novavax and Nio total returns in USD, 12/31/2019 – 12/31/2020.
Investing in stock markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance is no guarantee of future returns. International currency fluctuations may result in a higher or lower investment return. This document constitutes the general views of Fisher Investments and should not be regarded as personalized investment or tax advice or as a representation of its performance or that of its clients. No assurances are made that Fisher Investments will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts will be, as accurate as any contained herein.
