Index Fusion.

Fusion dining combines culinary delights from different cultures like Mexican and Chinese or Korean and Puerto Rican.  It blends the best of both cultures into one to try and please the palate.  Some fusion items include wasabi mashed potatoes, kimchi and avocado quesadillas, sake soy guacamole, and Japanese fish tacos.[1]

If it’s possible to fuse culinary indulgences why not apply it to investments?

Individual investors typically buy large-cap, blue chip stocks in names they know and trust with a tilt towards growth or value.  Growth investors favor momentum stocks with strong earnings and little dividend income like Facebook, Amazon and Netflix.  Value investors search for dividend income from companies like AT&T, IBM or Exxon.  It’s uncommon for individuals to own both growth and value stocks.

There are a few pitfalls in this strategy.  If an investor holds mostly growth or value stocks, they can miss strong moves from the style they don’t own.   For example, growth is outperforming value this year by 12.25%.  In 2016, value outperformed growth by 11%.[2]

In addition, individuals who concentrate on U.S. based companies ignore international ones.  International stocks account for about 48% of the global market cap so bypassing this asset class can leave a hole in your portfolio.  International developed markets have risen 20% this year and emerging markets have climbed 26%.

Bypassing small companies is another issue with a large-cap only portfolio.  Small-caps have outperformed large -caps by a wide margin and since 1928 they have gained more than five times large-caps.  A $1 investment in small stocks has grown to $21,413 and large stocks, $4,129.[3]

Finally, it’s difficult to achieve diversification with a portfolio of individual stocks.  Morningstar’s data base of global stocks includes 111,000 companies. You may own 30 to 40 stocks, a tiny fraction of the available options.  A 20-year study by Dimensional Funds found that owning all stocks produced an annual gain of 7.2% but if you excluded the top 25% of performers each year your average annual return dropped to a negative 5.4%.[4]

Here are three suggestions on how to fuse investment styles and beliefs.

  1. Invest in a diversified portfolio of low, cost mutual funds. A balanced portfolio of U.S. stocks, international stocks and bonds will give you access to 1,000s of investments.   A mutual fund portfolio consisting of 80% stocks and 20% bonds managed by Dimensional Fund Advisors owns 15,256 investments from around the world.   It’s up 17.25% for the year and has returned 10.98% per year for the past five years.[5]
  2. If you want to own individual stocks, allocate 5% to 10% of your capital to a few names and then index the remainder.
  3. Complete a financial plan to determine your asset allocation mix and risk tolerance. Your plan will help formalize your financial goals and define your investment selection.

January is a great time to review your accounts and look for new opportunities.  2018 could be your year to feast on investments from around the globe.  Bon appetit!

And what, Socrates, is the food of the soul? Surely, I said, knowledge is the food of the soul. ~ Plato

Bill Parrott is the President and CEO of Parrott Wealth Management an independent, fee-only, fiduciary financial planning and investment management firm in Austin, TX.  For more information please visit www.parrottwealth.com.

December 21, 2017

Note:  Past performance is not a guarantee of future returns.  Your returns may differ than those posted in this blog.  Investments are not guaranteed and can lose money.  Options involve risk and are not suitable for all investors.

[1] https://www.sunset.com/food-wine/flavors-of-the-west/fusion-cuisine#fusion-cuisine_2, website accessed 12/18/17.

[2] Vanguard ETF’s: VUG and VTV, 2016 and 2017 returns.

[3] Dimensional Funds 2016 Matrix Book.

[4] Dimensional Funds Investment Principles: 1994 – 2015.

[5] Dimensional Funds 80/20 portfolio: DFEOX, DFSTX, DFIEX, DFCEX, DFREX, DFTEX ending 12/20/2017.

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