A Better Investment Experience | Brandon Averill, Justin Dyer | AWM Insights #27

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Episode Notes

Recent headlines are reporting massive drops in tech industry giants like Apple, which dropped last week by a little over 9% - roughly $150 billion of market value, and Tesla is down again this week after a similar fall last week. Have they reached the bottom? As we have said before – there is no crystal ball to determine that.

However, there are investing concepts that are critical to understand to better weather volatile seasons like 2020 has turned out to be that will help you shore up unnecessary risk and capture the gains you deserve. AWM’s Chief Investment Officer Justin Dyer returns this week to discuss this concept with Managing Partner Brandon Averill.

Key Topics:

  • What is concentration risk?

  • Putting your eggs in one basket

  • Thoughts on the recent tech stock volatility

  • One of the most important tools in an investor’s toolbox

  • Should I hold these companies that experience big run ups? (For more info, see our recentx episode: Tech Stocks Are The Highest Performers – Should You Get In?)

  • Relying on the data to inform investment decisions

  • The top 10 largest stocks since 1994

Resources

Download the resource Brandon referenced from Dimensional Fund Advisors, “Large and In Charge? Giant Firms atop Market Is Nothing New.”

+ Read the Transcript

Brandon Averill (00:00):
Welcome to AWM Insights which is a quick hit each week on timely investment topics. I am Brandon Averill a partner with AWM Capital and I'm joined by my cohost Justin Dyer, AWM CIO. Today's conversation is jumping into the topic of concentration risk and diversification. Justin, welcome to the show.

Justin Dyer (00:19):
Thanks, Brandon.

Brandon Averill (00:20):
Yeah. I'm excited to jump into this Justin. We've seen obviously some real volatility over the past couple weeks and really the last few days. It's left a lot of people wondering why is the market going down and there's a lot of reasons. We could probably take tangents into that but I think it's also just a good reminder when we go through events like this to remind ourselves where we need to be from a portfolio construction standpoint, and that's diversification. And I'd like to dive in a little bit today, just explain what concentration risk is, why we take into consideration why we want to smooth some of that out to give ourselves a good investment experience over time.

Brandon Averill (01:01):
So Justin, I'd love to hear just your thoughts as you're reading the news right now and you're seeing a lot of these tech stocks really take a hit over the past few days and obviously they've benefited the portfolios over the past couple months. When you think about concentration risk, reading this stuff, what's coming to your mind?

Justin Dyer (01:17):
Sure. Yeah. It's been an interesting year to be an investor for sure, and the technology side of the market certainly has been cause for quite a lot of that interest and excitement if you will, but at the end at the day diversification still is a primary portfolio construction rule, and it's what your mom used to say, right? Don't put all your eggs in one basket, and that definitely rings true to this day regardless of how technology stocks have performed. It certainly is understandable why you would see the performance of technology stocks so far this year and get excited about them, or fear of missing out if you will, good old FOMO there.

Justin Dyer (01:59):
But at the end of the day remaining diversified and disciplined will actually generally give you a better investing experience and produce higher expected returns over the long-term, so what you don't want to do is overly tilt your portfolio to one company or sector because generally speaking you're going to be late doing that, right? If you put all your money into technology after the big run-up, well, you see all this volatility we're experiencing now. Now, that's not to say we know that it's going to continue going down from here. We don't. We can't predict the future, but by taking on that additional risk you would've been putting too much capital at risk and experienced a pretty big draw down here.

Justin Dyer (02:42):
When you saw Apple last week drop by a little over 9% which equates to around 150 billion dollars of market value that's pretty significant. Tesla down today another 17% after falling over 9% last week, or on a single day last week that is. So concentration risks really just it introduces risk into the portfolio that is unnecessary for long-term investors. We are a diversified. We're spread out across the world, across different industries, and that gives you a smooth ride. It's the better way of having higher expected returns, and avoiding big market drops.

Justin Dyer (03:25):
And on the flip side of that you do avoid big market run-ups, but at the risk of experiencing what we're seeing currently. That's worth not participating on the upside of things.

Brandon Averill (03:36):
Yeah, no, I think it makes sense. I think the other thing to keep in mind too is we're not saying don't hold any of these companies. What we're saying is that you want to hold everything and you want to allocate yourself certainly to higher expected returns, and that we've hit on in previous AWM Insight episodes and we'll hit on again in the future, but what we do know and we've quoted it before is that if you guess wrong, if you're picking stocks and you happen to let's say miss out on the top 10% of performers, there's a period that we can pull stats from, 1994 to 2018.

Brandon Averill (04:09):
That would've affected your global market performance by about 5%, so instead of getting that 7.25% from a diversified portfolio you would've ended up with a 2.9% return. And then, if you happen to really miss wrong and exclude the top 25%, I mean, you're looking at a pretty substantial negative return. And it just goes back to all the research shows that there's just no reliable way to predict what those top performing stocks are going to be, and so what we need to do is just look at the data and acquiesce to the fact that, hey, nobody has a crystal ball. Anybody that tells you that they know what's going to happen in the future is most likely a sales pitch and something you need to stay away from.

Brandon Averill (04:54):
I was reading a headline this morning, and I'll quote it for you. "A top heavy stock market with the largest 10 stocks accounting for over 25% of market cap and a marquee technology firm perched at number one." This sounds like a description of the current stock market. Dominated by Apple and other FANG stocks, but when we looked at it what it actually is a reference to is 1967 when IBM represented an even larger part of the market than Apple does today, or did at the end of 2019, and that was 5.8% to the .1%.

Brandon Averill (05:28):
So I think the message here is this is nothing new. When you start to look at the market as a whole you're going to have concentrations of performers at the top in every market. I think the biggest thing is we just don't know which performers, so you certainly don't want to take the guesses and potential miss out and cause yourself some undue angst from trying to be a stock picker. That's for sure.

Justin Dyer (05:51):
Right, and I'd just add that hindsight is 20/20, right? Don't get caught up by looking backwards. Take the high probability, higher expected return approach of investing for the long-term going forward. Don't get too caught up in the current and what has happened recently because it does not predict anything measurably of how markets will perform going forward.

Brandon Averill (06:14):
Yeah. I think that's a great point and there's a fantastic chart that we'll post to the show notes, or put a reference to, but it comes from Dimensional Fund Advisors, and they plotted out the largest 10 US stocks at the start of each decade, and it's pretty fascinating to see just the change over decade to decade. They change over so often. New companies we just referenced, IBM from the '60s, certainly Apple today. We've had Amazon in there for a couple years.

Brandon Averill (06:42):
But the changeover is just too random to try to predict, so I think everybody listening to this will certainly be pretty fascinated by that. And so, what we've seen, these events in August, and over the past few days we just want to reiterate the importance of having a well diversified portfolio. It's tempting. It's really tempting, especially if you've got that gambler in you to go for the big win, but we also know if you go for the big win you potentially are going to set yourself up for a big loss.

Brandon Averill (07:10):
So we don't want to do that with our investment portfolios. We want to take that steady kind of tried and true approach, and give ourselves the best investment experience that we possible can. So with that, we're going to conclude. I really encourage you guys to visit awminsights.com for the show notes and to learn more about this topic, and other episodes. If you want to be the first to hear the next episode please go sign up for our newsletter. Certainly, we'd love to hear your thoughts. What do you guys want to hear from Justin and I?

Brandon Averill (07:39):
And with that, we're going to sign off. Stay hungry, stay humble, and always be a pro.