Many advisors and clients are frustrated with portfolio performance from 2012 to date but for very different reasons. Clients are frustrated due to well publicized returns from 2012 through 2014 for the S&P 500 index and perceived portfolio “underperformance”. Many advisors are just as frustrated because, after all, we want our clients to generate reasonable returns -- but at an acceptable level of risk. Diversifying to diminish risk has also diminished returns for the past few years. This all begs a few points for clients and advisors alike to consider.
- Diversification at its very root is a deal. The deal is: never attempt to make a killing in order to avoid being killed. It is simply the old and proven notion of not having too many eggs in one basket. If you have eggs in many baskets and one gets kicked over, it is painful, but not fatal. Solomon, the wisest man who ever lived if you believe the Bible as I do, said something like this in Ecclesiastes 11:2, “Divide your portion to seven, or even to eight, for you do not know what misfortune may occur on the earth.” Solomon didn’t know much about the S&P 500 index but he knew a lot about accumulating a fortune.
- What is “underperformance”? Is your goal to fund retirement, education, legacy, etc. or to beat an index? Utilize a well-constructed plan to avoid intuitive and emotional decisions that can destroy your desired future outcomes.
- Avoid media bias in decisions. Unfortunately, the financial media focuses on a few indices such as the S&P 500 (only large cap U.S. stocks) and the Dow Jones Industrial Average (an even smaller pool of large cap stocks). Neither these or other single indexes typically mirror a broad range of assets. The news for lack of diversification in these indices is actually even worse. Much of the movement in the S&P 500, for example, will often be concentrated in a small number of companies. If number 250 in the index is up 20% this year, it’s impact on the index will not be nearly as dramatic as if number 5 is up 20%. Large moves up or down can often be very narrow. People quickly forget the S&P 500 dropped over 50% in the 2008/2009 financial crisis.
- Patience is critical and difficult. Three or even five years does not a lifetime make. Good or poor performance can last awhile. Great five-star funds in Morningstar’s database will often go through periods of years in the bottom half or even quarter of performance against their peer group. The reason is simple. Great managers are not buying companies who they assume will do well for the next couple of years but for decades. Can circumstances change their view? Certainly, but not the overall investment philosophy.
- The very fact that some assets are doing well and others not so well in any given year is exactly why advisers rebalance to a planned. They are simply selling what has done well and buying what has not done so well. Do it at the same time every year systematically (not because of a hunch) and it works beautifully.
Plan to succeed and work the plan. Failing to plan is just that, failing.
Gary James C.P.A., CFP®, AIF®
Vice-President, Financial Advisor
Neither diversification nor systematic investment plans can assure a profit or protect against loss in declining markets, and they cannot guarantee that any objective or goal will be achieved.
All indices are unmanaged and investors cannot actually invest directly into an index. Unlike investments, indices do not incur management fees, charges, or expenses.
Investments are subject to risk, including the loss of principal. Because investment return and principal value fluctuate, shares may be worth more or less than their original value. Some investments are not suitable for all investors, and there is no guarantee that any investing goal will be met. Past performance is no guarantee of future results. Talk to your financial advisor before making any investing decisions.