Q: My friend put all of his money into big tech stocks and Bitcoin a year ago, and his returns are absolutely smashing mine. I thought diversifying my portfolio was the smart thing to do, but now it feels like I will have to work forever compared to him. Any recommendations?
A: The bad news with a diversified portfolio is that it will never be the best portfolio over any given time period. The good news is that it will never be the worst portfolio over any given time period either.
Investing is a long-term game. While awards might be passed out to professional investors for accomplishing superior short-term returns, for the individual investor trying to build a retirement nest egg, only long-term returns count. In fact, there are no rewards passed out to individual investors, and investing is a one-player game. You are not competing against your friend or any other investor. You are only competing against your own financial goals, and success is only measured by whether you accomplish them.
Diversification is a critical principle of investing. When building a portfolio, your goal is to select a portfolio that is highly likely to accomplish your goals given a wide range of potential future scenarios. Of course, only some of those potential futures will materialize. Given the plethora of gamblers and speculators in the market who make large bets with their portfolios, surely a few of them at any given time will have made the correct bet on which investments will outperform. In this case, your friend is one of them. He gambled and won. What you are not seeing, however, is the number of investors who made similar gambles but lost. Undiversified investors take massive losses and even go broke all the time. There is good reason for the old adage, “Don’t put all of your eggs in one basket.”
Often when we see another investor who has bet correctly on a short-term market movement, we feel a sense of loss, of what could have been. This is often called “fear of missing out,” or FOMO. FOMO can, unfortunately, lead investors to abandon well-thought-out plans in hopes of also making the right bets and getting rich quickly. In many ways, the investor matters more than the investment. Your ability to follow a reasonable, written investment plan through thick and thin is far more important than which of many reasonable investing plans you have chosen to follow.