When I look at social media these days, I cannot tell if the world is coming to an end, or if we are about to embark on our nation’s greatest moment. For the first time in our history, a presidential transition was followed step-by-step on social media, and the reaction is frightening. Consider that only 25% of American adults used social media in 2008, compared with over 65% in 2015. The outcome: too much information. It’s nearly impossible to process it all, especially now that we have claims of “fake news” everywhere. As if investing weren’t emotionally difficult to begin with, now we are trying to filter our decisions through the deafening political noise. Remember when it became clear on election night that Donald Trump was going to win the presidency? The stock market futures plummeted only to reverse themselves a few hours later and begin what was dubbed The Trump Effect, a jump in the Dow Jones Industrial Average of 8.2% from November 9 – December 31. Keep in mind that President Trump took office with the lowest approval rating of any incoming President in history. So what are we left to believe when making investment decisions? How do we begin to manage our investment portfolios?
A truth that you can hold onto – your portfolio will outlast any president, or congressional term. Portfolios are measured in decades. Politicians are measured in years.
Now, let’s examine the ways in which we can invest, as that will set the stage for an answer to our predicament. For purposes of this article, we are going to eliminate real estate and other illiquid investments. Our focus will be on the more basic asset classes of stocks and bonds. We could buy an individual stock or a bond, such as Coca-Cola (KO). That comes with concentration risk. What if Coca-Cola is the next Enron (unlikely, but follow along)? We could buy a sector fund, one that invests in Consumer Defensive companies like Coca-Cola. That’s a little more diverse than just owning a single stock. Or we could opt for a Large Cap Value fund which invests in a broad array of very big US companies who analysts believe is currently priced below its true value. Now we get exposure to a variety of market sectors, again providing greater diversification. The next level up would be to invest in a broad US stock fund, which would cover not only multiple sectors, but multiple sizes of US companies. Finally, we could buy a global stock fund, which as it sounds would own all sectors, sizes, and geographical locations around the world. This would be the broadest form of stock diversification we could buy. It is likely that the broader your investment strategy becomes, the less likely you are to have oversized performance; however, you also cut down dramatically on your risk of total loss. Total loss, not volatility. Total loss is what devastates our retirement plan. Volatility just gives us heartburn.
Now let’s consider the reach that President Trump really has on your portfolio. Let’s assume that during the Super Bowl, Coca-Cola had run an ad with leading man Alec Baldwin mocking the President. In a Twitter rage, he declares that effective the following Monday, the US is now imposing a 25% tax on all products that use high fructose corn syrup! The impact could be devastating to Coca-Cola and very impactful to that sector but the further up our strategy (from individual stock to global stock fund) you go, the lesser the impact will be on your portfolio.
Looking at a more current scenario, one can easily see how the same thinking applies to the recent discussions about taxing goods from Mexico to help build a border wall. Immediately, company names come to mind that may be impacted by that additional tax. Entire industries could be adversely affected. However, it will not impact all business around the world. Instead, it would likely create new trading partners over the long-term, just as it would change consumer purchase habits. Consider the auto industry, where many parts are manufactured in Mexico. This tax would not bring the auto industry to its knees, but it could certainly impact manufacturers who rely on parts from Mexico. That could affect prices of certain cars which will affect consumers. Rather than stop driving, I am certain consumers would eventually begin buying cars that are not affected by this price increase. If you hold a specific auto stock, you could be left watching your investment value shrink – quickly. A more broadly diversified position would be more immune to these legislative impacts.
The first lesson for investing in a Trump world – be diversified. When possible outcomes seem unpredictable, it is a good time to spread your risk through diversification. We prefer broad based, low-cost index positions that track universally accepted benchmarks.
One final thought from Bob Cochran, our Chief Investment Officer: Today’s headlines and tomorrow’s realities are seldom the same.
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