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Asset Class Wheel Analogy

Break the Wheel

August 2, 2017 by Brendan Mullooly, CFP®

Game of Thrones is one of the most popular shows on TV. I was a little late to the game, but hopped on the bandwagon in 2016 and haven’t looked back. One of my favorite moments from the show was an exchange between Daenerys Targaryen and Tyrion Lannister. Daenerys describes the ruling families of Westeros by comparing them to a wheel:

“Lannister, Targaryen, Baratheon, Stark, Tyrell they’re all just spokes on a wheel. This ones on top, then that ones on top and on and on it spins crushing those on the ground.”

She goes on to say that she wants to break the wheel.

Investors should take note of this and break their own wheel, rather than be crushed by it. (Excuse my poor artwork)

Asset Class Wheel Analogy

Just like the various houses on Game of Thrones, asset classes are just spokes on a wheel. They will come into and out of favor, often in swift and dramatic ways. The performance chasers get crushed on the ground.

It’s really tough to determine which asset classes will outperform ahead of time with any consistency. In fact, I’m willing to guess that by the time the average investor realizes an asset class has been outperforming, mean reversion should be more of a concern than FOMO. Sadly, performance chasing is something of a ritual among investment amateurs and professionals alike. Watching investors realize something is outperforming is like watching five year olds play soccer: they swarm around the ball where ever it goes.

To further visualize how difficult identifying outperformance ahead of time can be, check out this asset class performance quilt from Ben Carlson of Ritholtz Wealth Management.

Asset Class Quilt Through 2016
http://awealthofcommonsense.com/2017/03/updating-my-favorite-performance-chart-for-2016/

My drawing of the investor getting crushed by the wheel is simply a re-imagined version of this quilt.

So how can investors break the wheel? Diversification.

The problem is that diversification always looks stupid in hindsight. That stupidity can be magnified on a year to year basis, as the pseudonymous “Jake” pointed out today on Twitter:

Diversification benefits often play out in risk asset space over much longer time frames. pic.twitter.com/Xn97711JbE

— Jake (@EconomPic) August 2, 2017

Viewed in hindsight, diversification is nothing but a sunk cost, like insurance. It always would’ve been better to only own the top asset class, just as it always would’ve been better to not pay for insurance you don’t use. The problem is we can’t know what the top asset class will be ahead of time, just as we can’t know when we’ll need insurance before we do. As Corey Hoffstein of Newfound Research wrote:

“Viewed with the benefit of hindsight, diversification will always disappoint. To judge the outcome of diversification after the fog of uncertainty has lifted, however, misses the point: diversification provides us the incredibly important ability to admit we don’t know.”

So don’t get too bogged down by which spoke of the asset class wheel has recently been on top. The more important thing to do is make sure you don’t end up performance chasing yourself into oblivion. Diversify and break the wheel!

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Filed Under: Asset Management, Investor Behavior Tagged With: behavioral finance, long term investing

About Brendan Mullooly, CFP®

Brendan Mullooly is a CERTIFIED FINANCIAL PLANNER™professional with Mullooly Asset Management, Inc.

1971 State Route 34, Suite 102
Wall Township, NJ 07719

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The information on this website and blog do not involve the rendering of personalized investment advice. A professional advisor should be consulted before implementing any of the options presented. None of the content contained in this website should be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.

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