When it comes to reviewing investment portfolios, there is an interesting phrase that is often uttered. It’s usually a version of this: “Let’s take a look at the investments and get rid of the dogs.”
The dogs.
I’m not sure of the definition of an investment ‘dog,’ but I suspect it centers on securities that have performed poorer than expected over some – usually meaningless – period of time.
Investments do not perform on cue. So, trimming a portfolio of investments based on recent performance is curious at best. At worst, it’s a practice that will make you poorer.
The same sentiment is rarely applied to other investments, outside of stocks and bonds. Take farms, for example.
Imagine a farmer owns 10 plots of ground, all several miles apart. Each farm was purchased at a sensible price and each has productive, rich soil. Every year, after the crops have been harvested, the farmer compares the yields of the 10 farms, memorializing the figures in an old, tattered notebook. For decades, the results from the farms are quite similar – and quite good.
Then, one year, one of the farms fails to produce a crop. The summer rains stubbornly sidestep the farm and the crops wither away in the heat. At the end of the year, the farmer compares the yields of his 10 plots and disappointingly jots down a zero for the dry farm.
Hope springs eternal, though, and the following spring the farmer eagerly begins planting his fields. The weather is kind, allowing him to plant all but one farm, which caught a couple of early rains and is still too wet. It happens to be the same farm that was too dry the year before. Every time the farmer is ready to pull the planter out of the shed, a rain shower soaks the lone unplanted farm again.
As spring rolls on, the rains do not let up and the farmer, at last, determines it is too late to plant a crop, leaving the farm fallow.
At the end of the year, the farmer pulls out his old, tattered notebook and notates the yields for his 10 farms. Grudgingly, he scrawls a second zero in a row for the dry-then-wet farm.
Is the farmer disappointed? Surely. Does the farmer look to sell the troubled farm because of two bad years? Surely not. The farmer knows the soil is productive and its long-term prospects are promising.
The farmer does not consider the farm a ‘dog.’ It just had a run of bad luck. Time will prove its worth.
Stocks and bonds often fit the same bill. Every investment in a portfolio should serve a purpose. If that purpose is still valid, no amount of recent poor performance should diminish the investor’s enthusiasm for the investment.
It is common for investments to underperform for years at a time before ultimately making up for lost time and notching big gains. Clearly, if we could buy and sell at the right times, we could avoid the poor-performing years and bet the farm during the good-performing years. That is simply not possible.
Most people understand that. But if we recognize that we can’t time the market, then why do we think it is logical to sort the wheat from the chaff in our investment portfolios monthly or even annually? What looks like chaff may miraculously turn into the finest wheat if given enough time.
Investing is not as simple as selling the investments that have had poor recent performance and buying something “better.”
Unfortunately, it is awfully difficult to differentiate between a bad investment that should be sold immediately and one that just needs more time to work. But in my experience, far too many investments get labeled ‘dogs’ when they actually fall into the latter category.
Again, if there was a solid justification for holding the investment in the first place, which should be the case for all investments in a portfolio, then even a few years of underperformance should not be distressing.
In fact, it should be expected.