Dow Jones hits an all time high, the S&P is roaring, so people think their portfolios must be up bigly… Then they get their statements and are shocked to see little to no growth….
When people talk about the market they are usually referring to the US stock market and forget about the rest of the investing universe. Things like international equities, bonds and real estate are rarely brought up in the same sentence. However, the same people also forget that when they set up their 401k account or spoke to their advisor, the word diversification was brought up again and again. And to be a prudent investor they chose to spread their dollars across multiple asset classes in an effort to hedge their portfolio against a major decline in one area. At the time it was best decision they could make.
Today, the US markets are ripping higher while the rest of the asset classes are heading south. Effectively, negating all the positive growth in portfolios.
To put into real numbers: As of today 9/20/2018
- US Markets are up around 10% (growth up 19% while value is up 5%)
- US Core Bonds are down 2%
- International is down 2%
- Of course there are other asset classes. This is just an example.
(http://news.morningstar.com/index/indexReturn.html)
- Of course there are other asset classes. This is just an example.
So, if your portfolio is 60% equities (70% US and 30% Int) and 40% Bonds, what is your Year-To-Date return?
From the equity side:
4.42% from the US.
-.36 from the Int.
From the bond side:
-1.80%
Add it all up and your Year-To-Date return is 2.26%, which is way off from the US only returns of 10%
Are you pissed? Do you want to sell those negative pieces and go all in one asset class?
Which one?
Do you jump in to USA large cap now? Do you bet on the others?
This awesome table, created every year by Callan, shows the annual returns for each asset class since 1998 (https://www.callan.com/periodic-table/) You can see the wide dispersion of returns.
Example:
2000, +22.83% at the top to -30% at the bottom
2008, +5.24% at the top to -53.33% at the bottom.
2017 +37.28% at the top to 3.54% at the bottom.
To be able to guess which asset class is the one to go “All In” on is impossible. How many times do you see that the worst asset class in one year is the best one the following year…and vice versa. Do you want to ride that wave? Can you handle that?
But you should also to see that diversification allows you to spread your risk and returns over multiple asset classes.
In years where global equities move up in tandem with the US you will get above average returns (2017) while in the years they move in opposite directions (2014) you will feel that you are stuck in quick sand…. but at the end of the day diversification is not a tool to get above average returns. And that little piece is what most people forget!
The whole point of diversification is to protect your downside. To not put all your eggs in one basket… to spread your risk. In fact, most investing tools and techniques are designed to protect your downside. Everyone wants to be protected from the pain of losing money.
Even you.
So, when you see the headlines about the markets, understand what is and what is not being talked about. Understand the mechanics of your portfolio. Understand why you do what you do. And remember, diversification works when you do and don’t want it too….
–Jared S. Friedman CFP®
