The Danger of Chasing the Holy Grail

During a period when most investments have lost value, it is common for investors to seek out the few assets that are performing well and then gravitate their portfolio towards these.

I think this is particularly the case in an inflationary environment where any negative performance feels particularly painful.

When your portfolio is down for the year while inflation is running at close to 8% is frustrating. Isn’t the goal of investing to keep up with or potentially outperform inflation over time?
If it’s not, it should be. This is a very reasonable investment goal to have.

Global stocks and precious metals have a pretty good track record of accomplishing this. Even parts of the bond market have demonstrated success in keeping up with inflation long-term. Investors have a good long-term opportunity set in front of them.

The challenge is that there is no investment that will beat inflation every single year. Almost all risky investments will have years of spectacular performance, which can then be followed by years of miserable performance. They all experience some form of cyclicality. In any given year, their likelihood of outperforming inflation is probably in line with their likelihood of underperforming inflation.

The ability of any particular investment to outperform inflation over time is a result of a longer-term average and not a year-by-year scorecard.

When investors focus on the year-by-year results of an investment, there is a strong temptation to chase the proverbial “Holy Grail,” an investment that seems to be immune from the cyclicality of other risky investments.

Even in an environment like this, we can generally find investments whose returns have been outpacing inflation for the past few years without missing a beat. Why not invest our entire portfolio in these assets?

The answer as you are probably expecting is that there is no Holy Grail of investing. There is some characteristic of every risky investment that makes it cyclical. In some cases, chasing the Holy Grail may put you at risk of a 100% loss:

  • If the investment is new, it may not have a long enough track record for investors to have experienced its down cycle. There are many investment products out there that share this characteristic. Oftentimes Murphy’s law prevails, and we see this down cycle at the exact time we choose to invest.
  • If the investment is an individual stock, it is always at risk for losing the value it has amassed over several years. There are many examples throughout history of individual stocks that achieved impressive gains over years or even decades only to lose their entire gains over a short period.
  • The investment could be a scam or a Ponzi Scheme. The inflated and consistent returns promised by Ponzi Schemes make them appear to be a Holy Grail.
  • The investment may have significant counterparty risk.  The overall investment thesis may be sound, but the party that backs the investment is not financially strong.

The current investment environment is frustrating for all of us. However, a diversified and consistent investment strategy will continue to stand the test of time and I believe it provides the best odds of keeping up with or potentially beating inflation over time.

Don’t let the frustration of the day to day push you to seek out a Holy Grail that doesn’t exist. In attempting to find a great investment that consistently beats inflation, you may be taking on more risk than you would have ever imagined.

  • The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

    There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.