Which Market?

The NASDAQ is soaring this year despite the political turmoil, racial tensions, and a global pandemic. It has risen 18% so far, and it’s not showing any signs of slowing down as it climbs a wall of worry. A few media outlets and financial experts are referring to the rise as a bubble. Market Watch had this to say about the stock market, “If you still do old-fashioned, cold analytical analysis based on numbers, you’ll see that the stock market is significantly above the mother of support zones. It is now a bubble.”[1]

When individual investors refer to the market, it is the Dow Jones Industrial Average. Is it up? Is it down? Will it keep rising, or will it crash? If the Dow falls more than 250 points, it’s considered breaking news even though it’s less than a 1 percent decline. The Dow Jones gets all the attention, but what about other markets? Is it fair to lump all markets together? What about the other indices?

Morningstar tracks more than 84,000 indices or markets, so when someone asks what I think about the market, I wonder which one they’re referencing. If you own a diversified portfolio of funds, you probably have exposure to dozens of markets.

To find out if the market is overvalued, let’s dissect a traditional 60/40 portfolio – 60% stocks, 40% bonds.

Large-Cap Growth Stocks. This sector has been red hot for more than a decade. The primary fund for this asset class is the Invesco QQQ Trust – The Qs! Stocks in this index include Apple, Microsoft, Amazon, Facebook, Alphabet, Tesla, NVIDIA, and Netflix. This star-studded index is up more than 490% for the past ten years, and it is up 24% on the year. If stocks are in a bubble, it’s this sector.

Large-Cap Value Stocks. Value stocks have trailed growth stocks by a wide margin for the past few decades, and this year is no different. The Vanguard Value ETF is down 16% for the year and up 115% for the past ten. Companies in this index include Johnson & Johnson, Berkshire Hathaway, Exxon Mobil, Pepsi, and Amgen.

International Developed Markets. International stocks have barely budged for the past ten years, rising a paltry 24%. The MSCI EAFE Index (EFA) is down 10.2% for the year, hardly a bubble. Companies in this sector include Nestle, Novartis, Toyota, and Unilever.

International Emerging Markets. This sector is one of the worst-performing asset classes over the past decade. It has risen 6.4% – total, not per year. A $10,000 investment a decade ago is now worth $10,640. Popular stocks in this category include Alibaba, Tencent, JD.com, and Baidu.

Small-Cap Growth. This sector is showing some life this year because it invests in growth stocks. It is up 2.25% for the year, and it has risen 233% for the past decade. Stocks in this index include DocuSign, Moderna, Teledoc, The Trade Desk, and Pool Corp.

Small-Cap Value. As far as US stocks go, few have fared worse than this sector, falling more than 23%. In the past ten years, it has generated an 87% total return. Small-cap and value have been a disastrous combination this year. Companies in this index include PerkinElmer, Allegion, Gaming and Leisure Properties, and ON Semiconductor.

Mid-Cap Index. Mid-Cap stocks are down 6.6% for the year. Over the past ten years, they’re up 171%. This sector includes companies like Lululemon, Splunk, Chipotle, and Clorox.

International Small-Cap. This international sector is down 12.4% for the year, but up 57% over the past ten years. Companies in this index include Rightmove, Bechtle, and Avast.

Real Estate. Working from home (WFH) is taking a toll on real estate stocks. Malls, shopping centers, office buildings, and senior living centers are not doing well in the COVID-19 environment. Does it make sense to allocate money to this sector with all the negative headwinds? I believe it does because real estate stocks will also give you exposure to data centers, cell towers, storage units, and timber. Real estate stocks are down 16% for the year and up 63% for the past decade.

Short-Term Bonds. Short-term US government bonds are the safest investment in the world. They have risen .42% for the past decade, and they’re up .32% on the year. Treasury bills are shelter investments, providing you with liquidity and safety.

High-Yield (Junk) Bonds. Lower rated bonds, known as high-yield or junk bonds, trade more like stocks than bonds, especially when stocks fall. Junk bonds have lost money for the past ten years, falling 12%, and they’re down 6.75% in 2020. A few names in this sector include Ford, American Airlines, and Netflix.

Corporate Bonds. Corporate bonds are having a good year, rising 6.2%. They have risen 26% for the past decade. Companies in this category typically have strong balance sheets. A few quality names in this sector include Anheuser-Busch, Microsoft, Apple, and Oracle.

Gold. Gold typically does well when investors or scared or there is a hint of inflation. This year gold has risen 18%, and over the past decade, it has risen 42%.

Commodities. A commodity index includes gold, oil, sugar, soybeans, corn, copper, zinc, silver, etc. It has been a challenging decade for commodities, losing 14%. This year it is up 7% rising on the strength of gold, silver, and copper.

Your portfolio may include some of these components. At the start of this year, it would have made sense to allocate 100% of your assets to large-cap growth companies, but it’s not possible to know, in advance, which sector will outperform the others. For example, from 2000 to 2010, the large-cap growth index lost 49%, while emerging markets rose 102%.

So, is the market in a bubble? It depends on the market, of course. One of the best ways to protect your assets is to own a diversified portfolio of low-cost funds and rebalance them as needed. Rebalancing your accounts will keep your asset allocation and risk level intact.

Rather than worrying if we’re in a bubble and trying to time your buys and sells, focus on your goals, think long-term, and let the stock market help you create generational wealth.

History shows us, over and over, that bull markets can go well beyond rational valuation levels as long the outlook for the future earnings is positive.” ~ Peter Bernstein

July 11, 2020

Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.

The data source for the investment categories, names, and returns come from YCharts.

[1] https://www.marketwatch.com/story/the-latest-sign-of-a-stock-market-bubble-small-companies-claiming-to-disrupt-large-industries-2020-07-06, by Nigam Arora, July 7, 2020

It Still Works

After the Great Recession, a friend asked me if diversification still made sense. He followed up with another question before I could answer. He asked, “If my assets are diversified, how come I’m losing money?” I said diversification still works, but it doesn’t protect you against a loss. Diversification helps reduce your risk allowing you to create generational wealth.

During the Great Recession, bonds outperformed stocks, but stocks have topped bonds for the past ten years as the market rebounded from the recession lows. This year, so far, bonds are winning. Investing is not a binary event. Few investors allocate 100% of their assets to bonds or stocks and flip between the two depending on their temperament

Stocks can decline, especially after a 10-year bull market. Stocks enter correction territory about every three to five years. Over the past two decades, the market has realized drops of 30%, 40%, and 50%. The average decline for the past twenty years has been 9.3%.[1] The market is always correcting, always adjusting, so it should not surprise you when it falls.

Microsoft, Apple, Amazon, Facebook, Alphabet, and Netflix account for 21% of the S&P 500 Index and 48% of the NASDAQ 100. These super six companies generated an average total return of 280% for the past five years compared to a 39% return for the S&P 500. However, they have experienced periods of underperformance relative to diversified portfolios. Microsoft fell 71% from January 2000 to March 2009, and it took 17 years for it to reclaim its previous high. Apple fell 75% in 1985, 74% in 1998, and 80% in 2003. Amazon fell 93% during the Tech Wreck. And risk arrives quickly – like lightning. Last year Hilton, Hertz, and Southwest Airlines were up, on average, 33%. This year, as a group, they’re down 56%, and Hertz is contemplating bankruptcy.[2]

Stocks, bonds, and cash are components we use to build diversified portfolios. Stocks for growth, bonds for income, and cash for safety. Stocks are subdivided into large, small, and international companies. Bond maturities vary between a few months to several years.

A diversified portfolio has many moving parts, and depending on the market cycle; some are up while others are down. One goal of a balanced account is to keep people invested for the long-term, despite the roller coaster ride of the market. Dimensional Fund’s 60% stock and 40% bond portfolio is down 10.5% for the year. It has averaged 7.5% for the past twenty years, and it has risen 75% of the time. Since 1926 it has been profitable 78% of the time and generated an average annual return of 8.9%.[3]

How do you develop a diversified portfolio? It starts with your financial plan. Your plan will incorporate your hopes, dreams, and fears. It will integrate essential financial components to determine your risk tolerance and asset allocation. If your investments are aligned to your goals, you’re more likely to remain invested so you can capture the long-term trends from the market. A balanced account is designed to withstand several market conditions and endure for generations. Diversification still works because we don’t know in advance which investments will perform well. Therefore, a globally diversified portfolio of mutual funds is the best way for most people to invest. If you want to invest in individual stocks or concentrate your investments, do so in a taxable account so you can take advantage of the tax code.

As we continue to deal with uncertainty from the virus and rumble through a volatile market, focus on your goals, create a plan, think long-term, and good things will happen.

But divide your investments among many places, for you do not know what risks might lie ahead. ~ Ecclesiastes 11:2

May 7, 2020

 

Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and are not suitable for every investor.

 

 

[1] YCharts

[2] Ibid

[3] Dimensional Fund Advisors – January 1, 1926 to April 30,2020

What is Rebalancing?

We try to maintain a balanced life, eat a balanced diet, and, of course, we need balance to ride a bike. Balance is harmony. Investors should pursue balance; unfortunately, they rarely rebalance their portfolios, and they get too aggressive or too conservative at the wrong time.

Rebalancing is an excellent way to maintain your asset allocation and keep your risk tolerance in check, but what does it mean, and how does it work? When you rebalance your portfolio, you’re selling assets that have risen and buying ones that have declined – buy low and sell high. Rebalancing is done on a calendar basis – monthly, quarterly, or annually. Another option is to rebalance on a percentage basis. If an asset class rises or falls by 5% or more, you can adjust your portfolio by rebalancing. You can decide which model works best for your situation. Our firm rebalances based on the percentage moves of the asset classes in our models.

Let us look at a few moments in history to highlight this point.

1929

If your portfolio consisted of 50% stocks and 50% bonds in 1929, your equity allocation dropped to 23%, and your bond allocation increased to 77% at the end of 1932, a mix too conservative based on your original allocation. If you rebalanced every year, you would have sold bonds to buy stocks. However, this would not have been so easy during the Great Depression. The Dow Jones Industrial Average fell 65% in four years, so it would have taken a bold investor with a firm conviction to buy stocks. Without rebalancing, you had to wait until 1955 before your allocation returned to 50% stocks and 50% bonds.

2000

Stocks fell 43% during The Tech Wreck. If you started the decade with a 50% stock and 50% bond portfolio, it fell to 30% stocks and 70% bonds by the end of 2002. Twenty years later, your portfolio allocation is 40% stocks and 60% bonds. It has not yet returned to your original allocation because bonds have outperformed stocks for the past two decades. Bonds have generated an average annual return of 7.2%, while stocks have returned 5%.

2009

If you were fortunate to start investing in 2009, your stock returns have done exceptionally well, averaging almost 11% per year. If you started with an allocation of 50% stocks and 50% bonds in 2009, your asset allocation entering 2020 was 73.5% stocks, and 26.5% bonds – too aggressive based on your initial target.

2020

Stocks are off to a horrible start this year, and your original portfolio of 50% stocks and 50% bonds is now 45% stocks and 55% bonds after four months.

As you can see, balance is rarely maintained, and you must continuously monitor your accounts to make sure your portfolio stays balanced. If you do nothing, your portfolio can oscillate between too conservative or too aggressive – at the wrong time. For example, if you did not rebalance your accounts for the past ten years, your equity risk was too high at its peak in February, before the S&P 500 fell 34% in March. If you did not rebalance your accounts in 2008, your portfolio was too conservative to benefit from the rebound in stocks starting in 2009.

Here are a few tips to help you rebalance your portfolio.

  1. Rebalancing your accounts annually is recommended, but you can also do it monthly or quarterly. Due to the increased volatility in stocks recently, we are running our rebalancing models weekly.
  2. January is an excellent month to rebalance your accounts because most mutual funds pay dividends and capital gains in December.
  3. Your 401(k) plan may have an automatic rebalancing tab allowing you to set it and forget it. Your plan should give you the option to rebalance monthly, quarterly, or annually.
  4. It’s easier to rebalance a portfolio of mutual funds or ETFs than it is a basket of individual stocks or bonds. It’s not possible to sell a half share of a stock or a third of a bond. If you plan to rebalance your accounts, stick with funds.
  5. If possible, automate the process of rebalancing. It’s emotionally challenging to sell stocks when they’re rising, harder to buy them when they’re falling. Automating this process will remove your emotions from the buy and sell decisions.

Rebalancing may or may not increase your returns, but it will allow you to preserve your asset allocation and risk tolerance. If you invested $20,000 in 1992 in Vanguard’s Total Stock Fund (VTSMX) and Vanguard’s Total Bond Fund (VBTIX) – 50% allocation to each, your ending balance as of March 31, 2020, was $152,903. Your investment produced an average annual return of 7.5% without rebalancing. Your allocation, 28 years later, is 70% stocks, 30% bonds. If you rebalanced your account annually to an allocation of 50% stocks and 50% bonds, your return improved to 7.7% and your balance is now $160,156.[1] In this case, your allocation and risk level stayed constant, and your performance improved, which is the goal of rebalancing.

The key to long term financial success is to match your financial goals to your investment portfolio. A financial plan will help you identify your hopes, dreams, and fears. Once you complete this process, put your plan to work and rebalance your accounts often!

Life is like riding a bicycle. To keep your balance, you must keep moving. ~ Albert Einstein

April 16, 2020

Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.

 

[1] Morningstar Office Hypothetical

Trifecta

Picking a trifecta is difficult, at best. Identifying the first three winners of a horse race, in order, is called a trifecta. The 2019 Kentucky Derby had 19 finishers, so you had to choose from 5,814 potential combinations! If you were correct, the $2 trifecta paid $22,950.

During my career in financial planning, I’ve found three things to be true: individuals aren’t aware of the type of investments they own, how much risk they’re taking, or what level of fees they’re paying.

After meeting with someone, I’ll review their investments to give them an idea of their financial situation. Often, they’re surprised how they’re allocated, their risk level, and the fees they’ve paid. I’ll then compare the results to their financial plan to make sure all three (allocation, risk, and fees) are in sync. The goal is to achieve a financial balance.

Let’s look at the three components.

Asset allocation. Your asset allocation determines most of your returns and your risk level. You might be able to improve your results by investing when the market is low; However, the odds of picking a bottom are extremely rare.

For the past 45 years, a portfolio of 100% stocks generated an average annual return of 12.9%. A portfolio consisting of 100% bonds produced an average annual return of 6%. A balanced portfolio of 60% stocks, 40% bonds made an average annual return of 10.4%.[1]

The returns varied depending on the market conditions. The 100% bond strategy never lost money from 1973 to 2018. The returns have dropped dramatically since 1999; the average annual return has been less than 3% for the past 20 years.

The 100% equity portfolio has produced the best returns, but with the highest risk. From 1973 to 1974, it dropped 41.5%. In 2008 it fell 41.8%. Last year it was down 11.8%. To achieve double-digit returns, you need to take some risk.

The balanced portfolio had considerably less downside than the all-equity portfolio. From 1973 to 1974, it dropped 20.8%. In 2008 it fell 24.8%. Last year it was down by 6.2%. The losses have been about half those of the all-equity portfolio.

Risk level. Risk has several definitions. Losing money is a risk. Volatility is a risk. Longevity is a risk. Inflation is a risk. Liquidity is a risk. Investing all your money in a fixed income portfolio will expose you to inflation and longevity risk. Investing everything in the stock market exposes you to volatility and principal risk. It’s hard to identify your risk level, especially after a 10-year bull market. One test is to review your trading during the 2008 Great Recession. When stocks fell 50%, what did you do? Did you sell your shares? Did you buy stocks? Did you buy bonds? Did you do anything?

Using a service like RiskAlyze or Finametrica can help you determine your risk tolerance. If you’re curious, you can take a quiz on my website by clicking on the “free-portfolio risk analysis” tab located on the upper right-hand corner of my website. Here’s the address: www.parrottwealth.com.

Fees. The fees you pay for your investments matter. Of course, the lower your costs, the higher your return (all things being equal). If you and your brother-in-law own the same fund, but your advisor charges you 2% per year, and his advisor charges .5%, he’ll have better returns. Fees vary, so be aware. Your advisor may bill you by the hour, charge a flat fee, assess a percentage of your assets, or take a commission. Regardless, a fee is a fee. Also, your investments may include other charges if you own mutual funds, exchange-traded funds, or insurance products. If your investment is sold with a prospectus, you’re paying a fee.

If you’re not sure about your investments, then hire a Certified Financial Planner® to help you figure it out. But, before you do, ask your planner how they get compensated and what type of investments they recommend.

Last, completing a financial plan will help you organize and quantify your goals, so they’re in sync with your asset allocation, risk level, and fee structure – a trifecta!

A horse gallops with his lungs perseveres with his heart and wins with his character. ~ Federico Tesio

August 13, 2019

Bill Parrott, CFP®, CKA® is the President and CEO of Parrott Wealth Management located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level.

Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.

[1] 2019-Dimensional Matrix Book returns from 1973 – 2018.

What is Asset Class Investing?

Investors can invest for growth, income or preservation. The three asset classes that fit this bill are stocks, bonds and cash – stocks for growth, bonds for income, and cash for preservation. Since 1926, stocks have returned 10.2%, bonds 5.5%, and cash 3.4%. Inflation during this same time frame has averaged 2.9%.

Stocks can be further subdivided into large, small, or international companies. Bonds can be issued by governments, municipalities, or corporations. Each of these asset classes have their own unique qualities and characteristics.

Active money managers will try outperforming a benchmark by selecting investments they deem superior to the general population. In addition, they’ll try to time their trading based on market and economic conditions.  Some market watchers categorize active money management as aggressive or speculative.  This style of money management is expensive as they tend to trade more often and employ analyst, traders, and other support staff. It’s also well documented that most active fund managers fail to outperform their corresponding benchmark or index.

Passive money managers purchase the underlying index regardless of valuation or external forces.  An index manager won’t try to time the market and will hold their securities through all types of market conditions and cycles. The most popular index is the Standard & Poor’s 500 and since 1926 it has generated an average annual return of 10.2%. Managers who follow this index will own all 500 stocks and when Standard & Poor’s makes an adjustment to their index, fund managers will alter their portfolio accordingly. This investment strategy is rigid and doesn’t allow for much flexibility because the fund managers can’t afford to deviate from the index, also known as tracking error.  Since there is little trading and no need for a large internal research team, the fees are low.

Asset class investing is based on academic research and it allows for more flexibility than the other strategies. Like passive investing, the fees are low, and diversification is high. Since trading is flexible, it’s more tax efficient than the active management style.

Dimensional Fund Advisors applies factors to their asset class investing.[1] This strategy is based on the findings and research of Eugene F. Fama and Kenneth R. French.[2] The outperformance of the Fama-French factors is over time and they are as follows:

  1. Equity premium: Stocks outperform bonds.
  2. Small cap premium: Small companies outperform large companies.
  3. Value premium: Value stocks outperform growth stocks.
  4. Profitability premium: High profitability companies outperform low profitability ones.
  5. Term premium: Longer term bonds outperform shorter term bonds.
  6. Credit premium: Lower credit bonds outperform higher credit bonds.

Allocating your dollars across several asset classes is what makes this strategy popular. The chart below is often referred to as a financial periodical chart, skittles chart, or quilt and this one is provided by Ben Carlson at a Wealth of Common Sense.[3] As you can see, asset classes aren’t static, and they fluctuate often. For example, if you follow the emerging market sector in the yellow box, you’ll notice it’s either near the top or the bottom. In 2017 it was the top performing sector gaining 37.3% while this year it’s near the bottom with a loss of 1.57%.

Investors who don’t adhere to an asset class investing style get frustrated with underperforming sectors and sell them at, or near, the bottom before they rebound. Small cap stocks underperformed in 2014 and 2015 before claiming the top spot in 2016. Likewise, investors will chase returns by pouring money into the hot sector usually before it rolls over like they did with commodities in 2009 and 2010.

A friend of mine who works for one of the largest mutual fund companies in the world told me the unwritten rule for his firm is for employees to invest their bonuses in the worst performing equity fund they manage from the prior year because they know it will eventually rebound.

I, too, like allocating dollars to underperforming sectors because they’ll eventually return to favor. Another advantage of buying a down and out sector is that you’ll buy in at bargain prices, a classic buy low and sell high scenario. An unloved sector also offers tremendous value to the buy and hold investor.

 

 

In a model driven portfolio that diversifies dollars across several asset classes, you can take advantage of down and out sectors by rebalancing your account annually. When it rebalances, the model will sell overpriced assets and buy underpriced ones. This strategy will keep your original asset allocation and risk tolerance intact.

A model driven, asset class portfolio offers many benefits. You get access to thousands of securities across the globe buy owning low-cost, efficient mutual funds. Furthermore, you no longer must stress about finding the right stock at the right time, nor do you have to fret about market timing.  What could be better than a stress free, low-cost, model driven portfolio?

June 11, 2018

Barbecue may not be the road to world peace, but it’s a start. Anthony Bourdain

Bill Parrott is the President and CEO of Parrott Wealth Management firm located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process.

Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog.

[1] Dimensional Fund Advisors – Dimensions of Returns.

[2] https://www8.gsb.columbia.edu/programs/sites/programs/files/finance/Finance%20Seminar/spring%202014/ken%20french.pdf, Eugene Fama and Kenneth French, March 2014.

[3] http://awealthofcommonsense.com/2018/01/updating-my-favorite-performance-chart-for-2017/, Ben Carlson, 1/14/2018.

No. How Can I Help You?

Are customers always right?   Employees who work in the retail sector are trained to say “yes” to client requests and that they’re always right.  They sell the client what they want, not what they need. It’s hard to find a salesperson who says “no” to client requests.

If I order a triple bacon cheeseburger with guacamole, chili-cheese fries, and a chocolate shake the clerk is going to take my order, deliver my food, and move on to the next customer.  He doesn’t question my order or the ramifications it will have on my health.

My role as an advisor, however, is to recommend what clients need, not what they want. This means I regularly say “no” to client requests especially when it’s not in their best interest.  My goal is to make sure they follow their financial plan.  I want to say “yes”; I want to be the good guy but not at the expense of their financial wellbeing.

In December of 1999 I met with a client who wanted to know why he didn’t have a larger exposure to high-flying technology and internet stocks.  He was questioning his allocation to international, real-estate and bond investments.  He wanted to sell these holdings to buy NASDAQ traded stocks.  I told him “no” because of their rich valuations and that they didn’t fit into his long-range plans.  He didn’t like my answer, so he asked the branch manager to transfer his account to another broker.  A few months later the NASDAQ peaked and proceeded to fall 70%.

Today, investors are once again questioning the wisdom of diversification as bonds, real-estate investment trusts and value stocks underperform growth stocks like Facebook, Amazon, Netflix and Google (Alphabet).  Investors are ready to abandon their asset allocation models to chase returns. Of course, the path of least resistance would be for me to cave into these requests and give them what they want, but is this prudent? Let’s look at a few examples.

  1. From October of 1989 to December of 2016 stocks averaged 9.38% per year. If an investor missed the 25 best days during this stretch his returned dropped to 3.98%.[1]
  2. In 2008 the S&P 500 fell 37% and long-term government bonds rose 25.9%.[2]
  3. From 1994 to 2016 stocks generated an average annual return of 7.3%. If an investor didn’t own the top 25% of performers each year, he lost an average of 5.2% per year.[3]
  4. In 2015, Denmark was the best performing stock market in the world and Canada was the worst. A year later they switched places.  Canada was first; Denmark was last.[4]
  5. International stocks returned a paltry 1.6% in 2016 but gained 25% in 2017.[5]
  6. In Barron’s 2017 Roundtable one prediction called for interest rates to rise and stocks to fall.[6] What happened?  Rates, stocks soared.

It would be nice to own investments that only went up, but this isn’t possible.  Markets rise and fall. Sectors move in and out of favor.  After all, if all your investments went up at the same time you wouldn’t be diversified!

A wise strategy is to follow your financial plan, diversify your investments and rebalance them annually.

“Never ask a barber if you need a haircut.” ~ Warren Buffett

But about that day or hour no one knows, not even the angels in heaven, nor the Son, but only the Father. ~ Matthew 24:36

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.

3/1/2018

Note:  Past performance is not a guarantee of future returns.  Your returns may differ than those posted in this blog and investments aren’t guaranteed.  Photo credit = lisafx

 

 

[1] DFA –  Investor Discipline – Reacting Can Hurt Performance

[2] 2016 – Dimensional Fund Advisors Matrix Book

[3] DFA –  Diversification May Prevent You from Missing Opportunity

[4] 2016-Dimensional Fund Advisors Matrix Book

[5] http://awealthofcommonsense.com/2018/01/updating-my-favorite-performance-chart-for-2017/, Ben Carlson, 1/14/2018

[6] https://www.barrons.com/articles/stocks-could-post-limited-gains-in-2017-as-yields-rise-1484376687, Laurin R. Rublin, 1/14/17.