I was reviewing a client’s investment performance recently. Since he started investing with me three and a half years ago, his portfolio had grown by about 40%.

He was pleased with that, and he had reason to be. Measured against the goals we set when we started, he was already ahead of schedule.

Before the review, I checked something out of curiosity. He had moved his investments over from another platform, so I went back to see what he would have earned had he simply stayed where he was.

The answer was about 42%.

I will be honest. I felt a little disappointed, perhaps even slightly miffed. Had he never switched, he would have ended up with a little more.

What the higher number was built on

Then I looked more closely at what he had held before, and I was reminded why we had made the change.

His entire investment had been in a single Asia-focused fund. More than half of it was in technology. Nearly 80% was concentrated in Taiwan, China and Korea. More than 10% sat in one company alone, and a significant part of the fund’s growth came from that one company rising by around 400%.

Those were good returns. They were also returns that depended heavily on a small number of concentrated bets going right.

The portfolio we moved him into was diversified globally, without the same reliance on one region, one sector, one country or one company. It was not risk-free, of course. But its outcome did not hinge on a handful of holdings continuing to do exceptionally well.

So the two numbers look almost the same. How each one was reached is not.

Nothing went wrong, and that is the trap

Here is the part that makes this worth writing about. Over those three and a half years, the concentrated fund never had its bad moment. The bets paid off. Judged purely on what happened, it was the better choice.

That is exactly why judging an investment by its result alone is dangerous. A result tells you what happened. It does not tell you what you were exposed to while you waited for it. A risk that did not show up has not gone away. It simply was not tested this time.

It is easy to compare 40% with 42% once we already know how things turned out. It is harder, and far more useful, to ask what the concentrated fund would have looked like if those few bets had gone the other way.

What he actually needed

For this client, the question was never “what is the highest return available?” His plan was already ahead of schedule. He did not need the most he could possibly get. He needed a return that would carry him to his goals without depending on a few things going exceptionally well.

That is a different question, and it leads to a different portfolio. It also means accepting that, in some stretches, a more concentrated alternative will do slightly better. I would rather explain a two percentage point gap in a good period than a much larger one in a bad period nobody had prepared for.

A question worth asking of your own portfolio

If you hold investments that have done well, it is worth knowing what that performance was built on. How much of it comes from one region, one sector or one company? If that single source had a difficult year, what would the whole portfolio look like?

I have written about the questions a proper portfolio review should ask in You Do Not Own Funds. You Own Risks.

Performance tells us what happened. Risk reminds us what could have happened.

The figures in this article are approximate and describe one client’s past results, measured on the same basis over the same period. Past performance is not a reliable indicator of future returns.