Why I Disliked my Diversified Portfolio in 2014


Let’s face it; we live in a headline kind of world these days. One of the fastest growing media outlets, Twitter, only allows 140 characters. They might as well rename it “Headwitter”! I was reminded of the power of headlines recently as I was reviewing my personal financial planning; reflecting on the progress I have made toward goals such as retirement, estate, tax, life insurance, and investments. And, after reviewing my personal 401k plan, and witnessing single digit growth, my immediate reaction was probably similar to many other investors that utilize a prudent asset allocation strategy (40% fixed income and 60% equities). I’d be less than candid if I didn’t share that my immediate thought was, “I dislike my diversified portfolio”.

The headlines suggest it should have been a better year. However, knowing that the substance is below the headlines, and 140 characters can’t convey the whole story, my diversified portfolio performed just as it is supposed to in 2014.

The Financial Headlines

The financial news -- whether it be radio, print, or social media -- almost entirely focuses on three major market indexes; the DJIA, the S&P 500 and the NASDAQ. All three are barometers for Large Stocks in the United States; they are meaningless for additional assets found in a diversified portfolio such as international stocks, small and medium size stocks, and bonds of all varieties. It is true that large US stock indexes were at or near all-time highs throughout 2014.  It is also true that many other major asset classes gained no ground or were even negative for the year including: high yield junk bonds, small cap stocks, commodities, metals, energy, international stocks and emerging markets. Moreover, even within US large stocks there was vast disparity as large cap value stocks lagged large growth stocks by almost 50%!

How to Dig Deeper into Strategy & Outlook

Our firm utilizes a variety of resources in developing our economic outlook and asset allocation strategies including research from well-respected firms such as Russell Investments and Raymond James. Review the “Russell Balanced Portfolio Returns” graphic that provides a useful visual on how a variety of asset classes have performed since 2005. (Click below image to enlarge.)

This chart shows the historical performance of different asset classes, as well as an asset allocation portfolio (35% fixed & 65% diversified equities). The asset allocation portfolio incorporates the various asset classes shown in the chart and highlights how balance and diversification can help reduce volatility (risk) and enhance returns.Risk adjusted returns are always a worthy goal and, as I have written in the past, risk is always present and matters.

Do you recall 2008-2009 or how about the lost decade of 2000-2010? If you “see” a pattern in asset class returns over time, please look again. There is no determinable pattern. Asset class returns are cyclical and it’s difficult to predict which asset class will outperform in any given year. A portfolio with a mix of asset classes, on average, should smooth the ride by lowering risk over a full market cycle. I’d suggest if there is any pattern to see, it would be that a diversified portfolio should provide aless volatile investment experience than any single asset class. A diversified portfolio is unlikely to be worse than the lowest performing asset class in any given year, and on the flip side it is unlikely to be better than the best performing asset class. Just what you would expect!

Staying Focused & Disciplined

The current environment reminds me of the strong US stock market experienced in the late 1990’s.  During that time, unfortunately some folks were willing to abandon discipline because of increased greed or conversely, increased fear. Currently I sense an interesting phenomenon, an increase in fear. Not of markets going down, but rather a fear of being left behind in such a strong US stock market. As important as it is not to panic out of an asset class after a large decline, it remains equally important not to panic into an asset class. I believe maintaining discipline in both environments is critical to investment success.

Like the late 1990’s, many folks have taken note of the S&P 500’s outperformance of many other asset classes over the last five years and wonder why they should invest in anything else. The question is understandable. If you find yourself asking the same question, you might consider the following:

  • The S&P 500 Index has had tremendous performance over the last five years, but it’s difficult to predict which asset class will outperform from year to year. A portfolio with a mix of asset classes, on average, should smooth the ride by lowering risk over a full market cycle.
  • Fundamentally, prices of U.S. companies are hovering around the long-term average. International equities, particularly the emerging markets, are still well below their normal estimates and may have con­siderable room for improvement.
  • U.S. large caps, as defined by the S&P 500 Index, have outperformed international equities (MSCI EAFE) four of the last five years. The last time the S&P outperformed for a significant time 1996-2001, the MSCI outperformed in the subsequent six years.

Managing Risk

Benjamin Graham, known as the “father of value investing”, dedicated much of his book, The Intelligent Investor, to risk.  In one of his many timeless quotes he says, “The essence of investment management is the management of risks, not the management of returns.”  This statement can be counterintuitive to many investors.  As I have shared before, risk does not have to be an alarm; rather a healthy dose of reality in all investment environments. That’s how we meet life’s financial goals. Diversification is about avoiding the big setbacks along the way – it doesn’t protect against losses – it is used to manage risk.

So, if you are feeling like I did initially about your portfolio, hopefully after review and reflection you might also change your perspective like I did from “I dislike my diversified portfolio” to “My diversified portfolio - just what I would expect”. As always, if you’d like to schedule some time to review anything contained in this writing or your personal circumstances, please let me know. Lastly, our investment committee has been hard at work for several weeks and will be sharing 2015 comments in the near future. Make it a great 2015!

Timothy Wyman, CFP®, JD is the Managing Partner and Financial Planner at Center for Financial Planning, Inc. and is a frequent contributor to national media including appearances on Good Morning America Weekend Edition and WDIV Channel 4 News and published articles including Forbes and The Wall Street Journal. A leader in his profession, Tim served on the National Board of Directors for the 28,000 member Financial Planning Association™ (FPA®), trained and mentored hundreds of CFP® practitioners and is a frequent speaker to organizations and businesses on various financial planning topics.

Required Disclaimer: This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Any opinions are those of Tim Wyman and not necessarily those of Raymond James. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. The Dow Jones Industrial Average (DJIA), commonly known as “The Dow” is an index representing 30 stock of companies maintained and reviewed by the editors of the Wall Street Journal. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The NASDAQ Composite Index is an unmanaged index of securities traded on the NASDAQ system. MSCI EAFE (Europe, Australasia, and Far East) is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the United States & Canada. The EAFE consists of the country indices of 22 developed nations. Inclusion of these indexes is for illustrative purposes only. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary. Past performance does not guarantee future results. Diversification and asset allocation do not ensure a profit or protect against a loss. Raymond James is not affiliated with Benjamin Graham.