Ever since our retirement planning practice started in 1988 we have maintained a “goals-based” approach to the investment management aspect of our client relationships. Investment strategies designed around your specific income and growth goals while reducing volatility potential through global diversification1 made infinitely more sense to us than investing to beat an arbitrary and “misleading” market index like the S & P 500 or the DOW. Considering the chart below, our client portfolios are comprised of all of the “asset classes” indicated in the left column; whereas the S & P 500 is represented by only the first two asset classes (US Large Cap & US Large Cap Value).
Although the chart clearly illustrates how random investment returns are from year to year comparing each of the asset classes indicated, we have certainly gone through a more recent period where large company US stocks (which comprise 100% of the S & P 500 index) have outperformed other asset classes. Given the media misperception that this index is representative of “stock market” performance in general, it is understandable that investors might feel a need to compare, to some degree, their portfolio performance to that of the index.
The other question more recent market results raise is “why don’t we focus more on the asset classes that are performing well now and change things when other asset classes outperform?” Thirty years of managing client portfolios has proven to me that “market timing,” which is what this question addresses, is a recipe for disaster over the long-term. Although there are always “pundits” who might guess correctly once or twice, ultimately, it is only a matter of time before they guess wrong. For example, in 2017 Emerging Markets outperformed all other asset classes with a 37.8% return. It is the worst preforming asset class so far in 2018 (down roughly 4% through 9/19/2018, source: Morningstar).
Instead of attempting to market-time, and risk concentrating too much of your portfolio in asset classes we might “predict” will outperform (which, in turn, increases the chances of concentrating your portfolio in under-performing asset classes as well), our approach is to own a broad array of asset classes, and rebalance2 your portfolio at least annually to maintain a consistent strategy aligned with your long term growth and income goals. Although your portfolio as a whole will never match the performance of the best asset class in a given year, it should never be over-concentrated in underperforming asset classes either. Most importantly, this diversified strategy reduces volatility risk, which enhances the likelihood of staying invested – the most important element of long-term financial success, in our opinion.
The current trend of S & P 500 asset class over-performance has continued since 2010, and may provide the impression that this is an “investable” trend. However, extrapolating relatively short-term results into a long-term strategy is usually a mistake when it comes to investing. The following charts illustrate and compare the performance of the Dimensional Funds Global Index vs. the S & P 500 Index and cash (as reflected by Treasury-bill performance) from decade to decade since 1970. Although the Dimensional Funds Global Index is not an exact representation of your DFA (Dimensional Fund Advisors) portfolio, it is highly correlated to your portfolio and represents all of the asset classes owned within your accounts. Of course past results are not necessarily predictive of future results; however, the following information makes a convincing case for maintaining a globally diversified approach when focusing on long-term financial goals.
The 70’s – low growth, geo-political uncertainty and high inflation...
The 80’s – low taxes and global economic growth
The 90’s – emerging U.S. technology and new internet industries
The 00’s – 9/11, low interest rates, real estate/lending bust
Current decade – global recovery, high debt, political uncertainty
As you can see, the S & P 500 Index was down 9% for the entire decade from 2000-2009! This under-performance profoundly affected the cumulative returns for the entire period from 1970-2017 as indicated below.
As the previous charts indicate, it is difficult to determine the merits of a globally diversified strategy from decade to decade. However, as the following chart illustrates, over all twenty-eight rolling 10 year periods of time from 1980 to 2017 the Dimensional Equity Balanced Strategy Index outperformed the S & P 500 Index over 82% of those 10 year periods. That’s a pretty good batting average….
Although the return for each of our individually managed client portfolios will vary due to the timing of deposits and withdrawals, and overall equity fund exposure based on your long-term growth and income goals (the Dimensional Equity Balanced Strategy Index is 100% equity/0% fixed income), the fundamental strategy of maintaining global diversification through all market conditions has allowed our clients to weather the storms of multiple bear and bull markets over time. It is always important to remember, however, that no investment strategy will cure continually excessive portfolio withdrawals. So even though we have a high level of confidence in our long-term investment approach, we cannot emphasize enough the importance of annual, comprehensive portfolio reviews to help ensure we remain focused on your personal goals and objectives.
1Diversification does not protect against loss of principal.
2Rebalancing assets can have tax consequences. If you sell assets in a taxable account you may have to pay tax on any gain resulting from the sale. Please consult your tax advisor.
Disclosures: The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra IS or Kestra AS. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation. Comments concerning the past performance are not intended to be forward looking and should not be viewed as an indication of future results.
This material represents an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed by Kestra IS or Kestra AS as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. The indices mentioned are unmanaged and cannot be directly invested into. Past performance does not guarantee future results. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the US stock market. The Dow Industrial Average is an unmanaged index of 30 stocks.
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The information contained herein was prepared by the undersigned for informational purposes only and does not represent an official statement of your account at the firm. Neither the information nor any opinion expressed