“The beauty of diversification is it’s about as close as you can get to a free lunch in investing.” – Barry Ritholtz
One of my favorite investment quotes – just not this year. With many asset classes in the red in 2018, frustrations are mounting. Aren’t fundamentals fine? For the most part, yes, but markets have a habit of frustrating investors. While US stocks are up mid-single digits year-to-date, international stocks and bonds are down. I have had several discussions with clients that expressed the desire to get out of overseas stocks and bonds and put more money to work here in the US. When I ask why they wish to sell, the answer is because they are down. It’s human nature 101. We are hard wired to run from pain and seek safety. Studies have shown the sensation from fear registers 3 to 4x vs. the feelings of pleasure.
Taking a longer-term perspective and analyzing the data should help prevent a significant mistake. Looking at your portfolio and making decisions or drawing conclusions based on 9 months is tempting but not recommended. Consider the following:
• Diversified portfolios: While infrequent, a diversified portfolio can lose money in a calendar year. Negative performance occurred 4 times over the past 20 years (2001, 2002, 2008, 2015). My take is to not abandon the plan but look back longer term. 2017 was a banner year for diversified strategies and the past 3 years have been rewarding as well.
• International stocks: Over the past 20 years, international stocks have outperformed US stock in 10 of the years. Think long term: Since 1970, despite periods where one outperforms the other, annualized returns of international & US stocks are similar, with a slight edge to US stocks. My take is to own both.
• Bonds: In 6 of the last 20 years, bonds have outperformed US stocks. The years that bonds outperformed stocks the margin was high – on average by more than 10%. Bonds dampen volatility, as a bond bear market is losses of 3-5%. In contrast, stock bear markets are losses of 20% or more. Bonds exhibit very low correlation to stocks and provide an opportunity basket to buy other risky asset classes when their prices are down.
Looking back at history, some of the largest inflows of assets ever by investors into US stocks were in late 2000 and mid-2007. We know what happened next. Shortly thereafter, US stocks topped and then suffered significant bear markets with losses both times of more than 40%. Buying high (“winners”) and selling low (“losers”) may not be the best strategy. Keeping your emotions in check is one of the most difficult habits to master. Time tested strategies of diversification and rebalancing still remain the cornerstones of a sound strategy.
Consult your financial advisor before making any investment decisions.
Data: Morningstar, Kwanti. International stocks refers to the MSCI EAFE Index. US stocks refers to the S&P 500 Index. Bonds refers to the the Bloomberg BarCap Aggregate Bond Index. You cannot invest directly in an index. This is not a recommendation and past performance is not a guarantee of future performance.