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14
Nov

A Rising Tide Lifts All Boats…(But It Doesn't Mean They Are All Seaworthy!)

Posted by on in Investments

We have all heard the saying. There is some truth to the idea that when the economy is doing very well most of the people benefit in some way to some degree. This doesn't mean that all people benefit equally or even proportionately. Even when things are going very well there are bumps in the road or waves on the ocean. We need to remember that if the economy is doing well it indicates that the country as a whole is doing well based on averages. Anytime you average any numbers, you’ll come up with an average for the set but it will also have a median. Averages can be misleading; the median tells you that half the numbers are lower and the other half of the numbers are higher. The median acts as your center point or your balancing point. Why is this important?

b2ap3_thumbnail_boats-port.jpgIt is important because if you only look at averages you will be missing a great deal of the statistical information that is available to you no matter what the subject matter is. You could be researching investments or you could be researching Fantasy Football or Fantasy Baseball players. Let’s say a baseball player had a batting average of .302 the previous season. Most people would say he hit 302 but it is actually .302 which represents the average of all his visits to the plate. If he steps in the batter’s box 1,000 times he’ll get 302 hits. Let’s make this simpler and say for every 10 at-bats he’ll get about 3 hits. Here’s a very important question: Can you deduce from this batting average that this ballplayer will get a hit for each of his next 3-at-bats if he has not had a hit his last 7 trips to the plate? No!

Where are we going with this? If the S&P 500 Index has gone up an average of 14% in the previous 20 years does this mean it will go up about 14% this year or next year? No! We put too much emphasis on the average and we don’t look deeper. There are 500 stocks in the S&P 500 Index. If the Index climbs 14% in one year does this mean that every individual stock in the index climbed exactly 14%? No! One stock might have risen 80%, another 40%, another 10%, and another 1% while several others could have had negative returns yet the index climbed an “average” of 14%. Would you rather invest in the index and take the average of 14% or would you rather invest in the individual stocks that returned 80% and 40%? What about when the index is negative? Does this mean every individual stock had a negative return in that year? No! Would you want to invest in the index knowing it would return a negative average for the year?

The best investments are those which can stand on their own no matter what the overall economy is doing, and no matter if the tide is going in or out. Over time I have slowly shifted my thinking away from indexes and geographical investments. I learned the hard way that just because there were compelling reasons why the Brazilian economy should perform strongly the last few years leading up to the Olympics and World Cup, it doesn't mean that a Brazilian ETF will realize a great return. China may have a bright future but it doesn't mean you should invest in an ETF that invests solely in China. It would be wiser to invest in individual solid companies which would benefit from a more successful Chinese economy.

You might believe that a collection might be a wise long-term investment; there are many physical items that you could choose to collect such as cars, coins, stamps, paintings, sculptures, etc. Would a Yugo command the same return over time as a Ferrari? No chance! So you would invest in a “collection” or “index” of cars if you knew they could own Yugos, AMC Pacers and Pontiac Azteks? Research is key to making sound decisions no matter the subject matter. Asking the right questions and seeking the necessary information is critical to success. The next time you hear or read that this is the perfect time to make some investment ask yourself all the prerequisite questions. If investing were so easy we would all own some index funds and there would be no advisers, wealth managers or hedge fund managers.

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