Why Is My Portfolio Lagging The Market?

Most of you have seen the chart (in our office or elsewhere) depicting the long-term investment performance of stocks and bonds. As you may recall, small stocks (and within that category, small value stocks in particular) outpace large stocks by a sizeable margin in long timeframes. There are periods, however, where large stocks outperform. We are a few years into such a period, and this has caused some to question allocations to stocks other than those within the large growth category. As a colleague once exclaimed “asset allocation amounts to having something to always complain about.” Does this mean your portfolio is lagging?

Keeping Your Goals in the Forefront

It is tempting to think of the “stock market” as the S&P 500 Index or even the Dow Jones Industrial Average. The 500 stocks in the S&P 500 and 30 stocks in the Dow comprise only a small fraction of the overall stock market (there are about 12,000 listed stocks today). What is sometimes missing is the framework of our own personal goals.

By designing a portfolio that relates specifically to these goals, we reduce the need to participate in the “performance derby” where the only aim is to maximize returns. Investing outside of a goals perspective makes investors prone to significant errors. Protecting clients from costly mistakes is one of the most valuable components of our work with clients.

Investing is an emotional event because our reasons for investing in the first place are emotional. Recent experiences weigh more heavily upon our emotions than experiences that are more distant. Despite the near term performance of large U.S. stocks, investors need a balance of different types of stocks, including international stocks, in order to harness the power of the markets. As Americans, we sometimes have difficulty understanding that the U.S. stock market comprises less than half of the world market today. International stocks provide desirable diversification characteristics since they tend to perform differently than our market. Such is the case now, where most international stock markets are negative this year and the U.S. stock market, (particularly large stocks), is positive. There are many years where the reverse holds true.

Evidence Based Investing

Does diversification (holding different types of stocks and bonds) still work? For the answer, let’s quickly examine actual market history. Since 2000, there have been 7 years where a diversified portfolio of 60% stocks and 40% bonds outpaced the S&P 500. There have been 8 years (including 2014 so far) where the S&P 500 fared better. Remember, a diversified portfolio is designed to never be ”the winner” among different asset categories. That is, the balanced portfolio will not be the best, nor the worst performing asset category for any given year.

The following chart, the Chart Growth of $1, details the S&P 500 and a diversified 60% stocks/40% bonds portfolio from 1973-Dec 2011.

The diversified portfolio reflects about one-third more growth than the S&P 500 for this timeframe. Remember, you invest for some long term purpose and diversification indeed works…for the long term.

The Evidence Based Approach to investing that we utilize follows peer reviewed academic research. We apply this research through disciplined exposure to segments of the markets where higher long term expected returns exist.

Helping coach clients to focus on their long-term goals rather than narrowly defined investment performance is yet another way that we add value to our advisory relationships. We can control our goals. We can’t control the investing markets. Understanding long-term market history can truly be the antidote to failure. Ready for a real conversation?

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