As individual investors, we all have the inclination to focus on and compare ourselves and our portfolio to the highest levels of performance, including what's performing well at the moment. This is human nature – coupled with influences from media – that drives us to look for immediate gratification versus longer term rewards.
U.S. vs. International Markets
One recent comparison issue as it relates to stocks has been comparing returns of U.S. versus International stock markets. Over the last six years, the S&P 500 (a U.S. stock index) has had an annualized return of 11.6 percent while the MSCI World ex USA has returned 2.26 percent and the MSCI Emerging Markets Index has had a -2.28 percent return. So the question may arise: why do I own International stocks that underperform?
As noted in the first article from Dimensional Funds (see link below), failing to diversify can be quite costly over the long term. During the recent period of 2000-09, often called the lost decade for U.S. stocks, the S&P 500 had a negative cumulative return of -9.1 percent. Over that same period, the MSCI World ex USA Large Cap Value Index returned 48.7 percent; the MSCI World Ex USA Small Cap returned 94.3 percent; and the MSCI Emerging Markets Index return a whopping 154.2 percent. It would have been quite disappointing to be all in with U.S. stocks during that decade.
A further point to consider is that based on market capitalization, the U.S. accounts for only 52 percent of the global stock market. This figure may be a surprise to many who have always thought the U.S. market made up a larger majority of the global markets. The point here is a vast number of investment options and opportunities exist outside of the U.S. that should be considered in constructing a portfolio. While the performance of different country stock classes will vary, there is no reliable evidence that performance can be predicted in advance. Therefore, maintaining some level of global stock diversification – even during down times – leads to stronger total returns over longer periods of time.
Stocks vs. Bonds
A second point of investing diversification outlined by one of J.P. Morgan's global market strategists (see link below) relates to portfolios with different allocations of stocks and bonds. When markets are rallying and folks are feeling more "confident" the common question arises: why do I have a particular allocation to bonds when they are not doing so well? A classic comment is I am "underperforming" the market. Then when stock markets are selling off (such as the first two months of 2016), the question should I get out of the stock market altogether? is a familiar one. As the saying goes, there is no free lunch. Risk and reward go hand in hand. A more meaningful set of questions should revolve around this mindset: am I best positioned given my financial goals, risk tolerance and this particular stage of life?
A more conservative portfolio will never outperform an all-equity portfolio during rising markets. Then again, it will never go down as much during market selloffs. We consistently try to educate clients to avoid comparing their portfolios to the extremes – such as the stock index when markets are surging or bond index when markets are falling. Instead, comparing portfolios to benchmarks that are proportionate to their agreed-upon portfolio mix is a much more prudent approach.
As noted in the Barron's article, since March 2009 a balanced investment approach has underperformed an all equity portfolio. However, if you look at how three different stock/bond portfolios (40/60, 60/40 and 100 percent stock) performed during the financial crisis of 2007-09, a very different story emerges. All three portfolios declined during the market meltdown, the 40/60 portfolio lost less than a quarter of its value whereas the all stock portfolio lost more than 50 percent of its value.
As one might expect, the recovery period for each portfolio was very different as well. A portfolio with 40% stocks and 60% bonds fully recovered its losses less than nine months after the crisis ended, a 60/40 portfolio took about a year and a half before fully recovering.
Please see links to the two articles referenced:
Comparatively, a 100 percent stock portfolio took more than three years to get back to even – more than double the recovery period of the 60/40 portfolio and almost four times as long as the 40/60 portfolio.
Further, if you look at performance over a longer period from 2000-15, the balanced portfolios outperformed the all equity portfolio with less volatility.
Some Final Thoughts
Over longer periods of time, investors can benefit by having consistent exposure to both U.S. and International stocks. We can say with certainty that, yes, there will be further recessions on the horizon. While nobody can predict the future to know exactly when, maintaining a steady allocation of bonds help portfolios weather the storm of those volatile times.
Every client has a different and unique personal situation. A number of factors go into determining an appropriate portfolio - financial goals, stage of life, size of asset base and personal risk tolerance are a few of the items considered in helping to best determine and recommend an appropriate investment mix.
Our objective at Trinity is to invest and manage an appropriate portfolio specific to your goals, and to educate you along the way so you can remain composed during periods of uncertainty. We believe this long-term perspective helps you to have a healthy and informed attitude about risk and volatility. As your investment partner, we're committed to keeping you on track and moving towards achieving your stated goals.