If you have been holding a diversified portfolio, it's been a frustrating few years. Nothing outside of US stocks has been working. We have been counseling clients that sticking with their original plan of global diversification still makes a lot of sense since the tides will turn eventually. We may be seeing those shifts sooner than we thought. Below is a chart of showing the first month of the year:
Although a short time period, things have shifted in 2015. After a month, the US stock market (black line) is the clear loser when compared to the developed foreign markets (gold line) and the emerging markets (blue line). For the past five years, US stocks have gone up over 15% per year, while foreign developed stocks are up 5% and emerging market stocks are up 2% per year. It is not hard to understand why people might abandon diversification and just decide to stick with the US markets. The problem is that trends don't last forever. At some point the tides will change. This is not dissimilar from the 1990s. This decade was a great period for the US stock market with substantial economic growth ending with the technology boom. The US stock market had tremendous gains and outperformed almost every other asset class. Those choosing to concentrate their assets in large US companies at the end of this decade, because of that great performance, found that the next 10 years were horrific (taken from the Irrelevant Investor Blog):
Investors need to remember that if you are properly diversified, there two truths that you ALWAYS have to live with:
- You will always have something to complain about- something in your portfolio will be out of favor every year if you are properly diversified.
- You will never outperform the best asset class- in fact your portfolio will always fall somewhere in the middle of the asset classes you are invested in. In the case of 2014, if you have adopted a diversified portfolio, you should be upset you underperformed the S&P 500. It was one of the best performers
The upside of all of this is that your portfolio will never be as bad as the worst asset class in the portfolio, you don't have to try to "guess" which asset class to rotate into each year, and your returns will be much less volatile. We believe that this is a worthwhile tradeoff.
When it comes to investing, we've found that "I don't know" is one of the most powerful statements you can say to yourself to improve the performance of your investments.
"I don't know where the market is heading this year"
"I don't know what interest rates are going to do"
"I don't know if this stock is a good investment"
"I don't know what is going to happen in the global economy"
Most people have a hard time telling themselves these statements. We all want to feel like we have some control over our investments and the thought that we have no idea about the direction of the markets is a scary thing. But the simple fact is…you don't know. No one does. Once you embrace this simple truth, your whole outlook changes.
- You stop focusing on things you can't control or predict
- You start focusing on things you can control- diversification, discipline, taxes and fees
- You are more skeptical of sales pitches that rely on a manager's abilities
- You understand that when something sounds too good to be true, it is
- You discount every thing that you hear or read in the financial media (since they all claim to "know" what is going to happen)
- You look at managers who outperform as more lucky than skillful
- You demand to see real evidence to show that past performance is predictive of future results
"I don't know" is a powerful statement in many aspects of our lives, but when it comes to investing it is not only powerful, but freeing as well.
Have you ever done a post-mortem of your investment/economic thesis? Most people tend to have beliefs about the direction of our country, economy, and investment markets. Those beliefs are reinforced by reading and watching media that agree with us, which is one of the reasons for such polarization in our country today. How often do you hear someone say- "I was wrong"? More importantly, how often do you say it to yourself?
Several years ago I started going through this exercise and found I was wrong quite a bit. That is a major reason why our firm has adopted a low-cost, passive investment approach. It avoids the need of having to be right in order to create a successful investment experience for a client. Just for fun, I decided to rewind the clock and look at some of the commonly held beliefs five years ago, and how those beliefs played out:
- The US economy would continue to be in shambles due to increasing unemployment and dangerously high debt levels
- The real estate bubble had burst and it would take years for it to recover
- Commodities (particularly oil and gas) would continue to climb due to increasing global demand and a shrinking supply
- Emerging markets like China and India would be the big winners in the years to come because of lower debt levels, economic trends and favorable demographics
- Interest rates were going up because the Fed was creating a bubble and lenders would start demanding higher rates because the US would be considered not as likely to pay back their debt (due to our high debt-to-GDP ratio)
Maybe I am cherry picking here, but I would venture to guess that most of you reading this would have agreed with every statement above five years ago. And why not? These were all consensus views. The only problem is that every one of those statements turned out to be wrong. The US recovery over the past five years has been spectacular, real estate investment trusts are up over 12% per year, commodities have lost 5% a year, emerging markets have been trounced by the developed world, and interest rates have fallen even further.
You don't know the future, and I'll let you in on another secret; no one else does either. Not the hedge fund managers, economics professors, wall street strategists, or CNBC guests. Be honest with yourself about how often you are wrong with your investment decisions. It is the first step is creating a successful investment experience.
Information contained herein has been obtained from sources considered reliable, but its accuracy and completeness are not guaranteed. It is not intended as the primary basis for financial planning or investment decisions and should not be construed as advice meeting the particular investment needs of any investor. This material has been prepared for information purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Past performance is no guarantee of future results.