Jed and Jethro: A Tale of Two Investors

My friend Jed came into wealth from some bubbling crude a few years back and decided to invest some of that newfound cash. Now, being a simple but wise man, Jed knew instinctively that he shouldn’t put all his eggs into one basket, but he didn’t know what kind of baskets to use and how many eggs to put into each. So, he decided to seek some advice from a Certified Financial Planner™ professional. This highly trained advisor, bound by a strict code of ethics requiring him to provide Jed advice strictly in Jed’s best interest, recommended he diversify his investments because that would help reduce his risk and smooth out his investing ride.  

As a generous man, Jed gifted part of his life-changing windfall to his son, Jethro. Now, Jethro is also a simple man but maybe not quite as wise as his father. In fact, he was quite comfortable keeping all his proverbial cereal in one, very large bowl. He didn’t seek professional financial help, other than his friend from the bank, Jane Hathaway, who readily agreed with Jethro’s suspenders and more suspenders approach.

As luck would have it, both Jed and Jethro invested $100,000 in October, 2007 at the absolute peak of the stock market. Here is how each fared during the Great Recession of the next few years:

Jed:

• Jed’s CFP® advisor counseled him to diversify his investments 60% into stock mutual funds and 40% into bond mutual funds. This mix was appropriate for him, given Jed’s age and risk profile as determined by the financial plan his advisor developed for him.
• Jed’s 60/40 portfolio declined to about $70,000 by the stock market’s low point in March, 2009.
• His investments regained their original $100,000 value, however, by October, 2010. It was a wild ride, but peak to trough and back was only three years, so Jed felt relatively fortunate he was now whole.

Jethro:

• Jethro, taking his own counsel, invested his $100,000 entirely in the stock market, as defined by the S&P 500.
• By March, 2009, the lowest point of the market, Jethro’s portfolio had declined by 50% to $50,000 – considerably lower than Jed’s.
• In fact, it wasn’t until March, 2012 that Jethro’s portfolio climbed back to the $100,000 he started with. It took Jethro 17 months longer than Jed to recover!

By the time Jethro was back to his starting point, Jed’s portfolio had grown to about $120,000. That diversification strategy was paying off!

Here is some more recent data to further illustrate the benefits of diversifying one’s portfolio:

2018:

• Last year at the beginning of the 4th quarter, the stock market, as measured by the S&P 500, was up 9% on the year.
• The S&P 500 then plummeted almost 14% during the 4th quarter.
• The S&P 500 finished down 4.39% for the year.

2019:

• At the start of this 4th quarter, the S&P 500 has a total return of almost 20% for 2019.
• Over the last 12 months, however, the S&P 500 has returned only 3.72%. Quite a roller coaster ride if you’re into those kinds of thrills.
• Looking deeper, small stocks as measured by the S&P SmallCap 600, are down 10.25% over the last 12 months.
• Conversely, the U.S. Aggregate bond index is up 10.27% over the last 12 months.

The market inevitably moves but not all the pieces within it move the same way at the same time. And, as Jed demonstrated through the worst stretch of stock market performance since the crash in 1929, properly diversifying his portfolio to meet his needs and timeframe allowed him to recover sooner and profit more. And, although past performance may not be indicative of future results, that can make lounging around the cement pond even more relaxing.

Steve Byars, CFP®