The Indicator from Planet Money

Episode•January 2, 2025•8 min

Why to look twice when your portfolio is doing well

People with American stocks in their portfolio are likely very happy right now. U.S. stocks were on a tear in 2024. But to some investors, that's a reason to look a longer look at their portfolio. Today on the show, one investor makes the case for the only free lunch in finance: diversification. Related episodes: Invest like a Congress member (Apple (https://podcasts.apple.com/us/podcast/the-indicator-from-planet-money/id1320118593?i=1000680896233) / Spotify (https://open.spotify.com/episode/4FqZaTiIkrQQvQHvNXNKV7?si=c8345657e59a457a)) Rethinking what counts in investing (Apple (https://podcasts.apple.com/us/podcast/planet-money/id290783428?i=1000593326896) / Spotify (https://open.spotify.com/episode/4Zg6j0DAAewEiYvIADlan7?si=108caf2bf75045d6)) For sponsor-free episodes of The Indicator from Planet Money, subscribe to Planet Money+ via Apple Podcasts or at plus.npr.org (http://plus.npr.org/). Music by Drop Electric (https://dropelectric.bandcamp.com/). Find us: TikTok (https://www.tiktok.com/@planetmoney), Instagram (https://www.instagram.com/planetmoney/), Facebook (https://www.facebook.com/planetmoney), Newsletter (https://www.npr.org/newsletter/money). To manage podcast ad preferences, review the links below: See pcm.adswizz.com (https://pcm.adswizz.com) for information about our collection and use of personal data for sponsorship and to manage your podcast sponsorship preferences. Learn more about sponsor message choices: podcastchoices.com/adchoices (https://podcastchoices.com/adchoices) NPR Privacy Policy (https://www.npr.org/about-npr/179878450/privacy-policy)

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Transcript

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Npr.

0:11

People who had American stocks in their retirement fund or share trading app like Robinhood likely had a good year. Notwithstanding a few bumps in the road recently, it was a very good year indeed.

0:24

That's right. From Microsoft to Micron, US Stocks are on a rocket ship. They're leaving the rest of the world behind. And this outperformance has actually been going on since at least the Great Recession. So a lot of people are now taking an America first approach to their investments and forgetting about investing in the rest of the world. Dan Villalon is with AQR Capital Management.

0:46

The US Stock market has trounced the rest of the world, and so it's really hard to argue why people should be rebalancing back into the countries that have underperformed.

0:58

Dan, though, is trying his best to make that argument. This is the indicator from Planet Money. I'm Adrian Ma.

1:09

And I'm Darian Woods. Today on the show Corporate American Exceptionalism, Dan makes the case for why a stock market hot streak might give investors pause after the break. The S&P 500 is the index of 500 big American companies. As of this recording, its value was up 24% in 2024. In fact, on the whole, it's been an incredible last decade and a half. There is a global stock index that tracks the value of public companies from all around the world, and that's called the MSCI All Country World Index. And US Shares make up two thirds of that. In other words, US Companies are valued at double the rest of the world's public companies combined in that inde.

1:56

And so to understand what this means for investors, we first need to understand what's causing those big gains in those company valuations. Looking at the earnings of US Companies, on average, they have made out handsomely. Those earnings have gone up more than double in the US compared to the rest of the world since 2010. Now, critics will say a lot of that is concentrated in just a handful of tech companies. Also, they point out that the US Government deficits might be juicing the economy temporarily. So, for example, consumers might be buying more products from Apple or Walmart. But that can't last.

2:31

Regardless how much money these companies are making doesn't tell the full picture. Dan Villalon is a principal at AQR Capital Management.

2:39

As the US has outperformed, it has also become more expensive.

2:44

So take Amazon, for example. At the start of 2024, the share price was around $150. Now towards the end of the year, it was around $230. Amazon may be extremely profitable over the next 10 years. But a lot of people already think that. So when someone invests in Amazon now with that high share price, it's not as good a deal as it used to be.

3:06

I think, you know, finance, investing, it's. It's not like physics, it's not like gravity. It's not true that what goes up must necessarily come down. But that said, there tends to be a bit of a headwind to assets that are very expensive.

3:25

Maybe an investor truly believes that American companies and people and institutions and resources are the very best in the world. That doesn't necessarily mean that they should invest in only the U.S. what matters is whether that optimism is already priced in or not.

3:43

Yeah, that requires some pretty deep analysis and a real attention to markets that frankly, most everyday people don't have time for. And that's where one investor investing magic trick comes in. Diversification. Basically, investing in a lot of different industries in a lot of different locations,

4:01

not having all of your eggs in one basket is a great way to build a portfolio that's likely to hold up better than once dominated by one thing.

4:11

Whenever personal finance is discussed, diversification is one of the first words mentioned. And it's worth reminding ourselves exactly what it means and that it can be a challenging principle to follow.

4:23

Yeah, so for instance, a lot of people are heavily invested in the house they own, and that might be by necessity, but that's the opposite of diversification. One asset class, housing in one neighborhood. A diversified portfolio might mean being less focused on owning a house, but having more of a spread of investments in other asset types. You know, stocks and bonds, maybe a little gold or precious metals, basically all of them.

4:49

Diversification also means investing in lots of different industries, plus lots of countries. Maybe one year the US goes into recession, but Japan doesn't. Diversifying which countries people invest in would protect against losing a chunk of their savings.

5:05

Diversification is famously or maybe infamously called the only free lunch in finance.

5:10

And the free lunch is this. You've heard the expression higher risk, higher reward. And that is basically how markets work. Riskier industries, riskier countries, more chances to lose, but possibly a better return on investment when things go well. Now, if someone is diversified, they can still get some of those higher rewards while being insured. So if one company fails, another might do well. So it's a low risk, high ish reward.

5:38

But there is a cost psychologically, mentally, is the lunch may be free, but it's not easy to consume.

5:46

I mean, yeah, it's like you could have A perfectly balanced, healthy lunch. But is it really as fun as just like housing an entire bag of chips?

5:55

Yeah, a bag of chips is pretty easy to wolf down. And so what he's saying is that it's not easy to consume because these investors will be missing out on the really, really high gains that are possible when somebody goes all in on one or two companies.

6:09

So I've got three kids. I would say there's probably a 30% chance that one of them is misbehaving on any given day. So the question is, what's the likelihood that at least one of my three is misbehaving? Well, those odds are about 66%. And that's sort of. That's the flip side. That's the other side of the coin to diversification. You should expect that something in the portfolio is not doing well when you look at it, but it doesn't mean that the portfolio is impaired.

6:40

When an investor has a diversified portfolio, there can be this kind of fomo. Bitcoin just went to the moon. Meta stocks are up. What if they'd only invested in those things? Well, Dan says those thoughts can tempt investors away from diversification. And that brings us back to why it's particularly tempting now to stick with only US Stocks.

7:02

The US has become pricey, and other markets, you know, even though they are less loved, may be offering a better deal over the next five to 10 years. I would never say to get out of a market altogether, but I would use that as an encouragement to get folks to diversify a little better across all.

7:20

In some ways, if someone's been heavily investing in US Tech stocks recently, it must feel like they've stumbled upon a gold mine. So why would they pack up and explore elsewhere?

7:31

I think people are a little asymmetrical when it comes to this. I think most people, they see bad and they say, I've got to change something, but when they see too good, they don't also kind of decide to change something. You want to kind of get more of the losers and have a little bit less of the winners. Because if you don't do that, if you don't have that kind of regular maintenance of your portfolio, you could end up missing some of that free lunch, some of that, some of the value of diversification.

8:00

Leaving when the party's just getting good can be hard, but Dan says it can be wise to have other options for when things start to get messy.

8:12

This episode of the Indicator was Produced by Cooper Cat's McKim with engineering by Neil Tivolt it was fact checked by Sierra Juarez Cake and Cannon edits the show and the indicators of production of npr.

Why to look twice when your portfolio is doing well

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