Lewisburg, PA – Tonto: “The market is up and I am not. What’s the story Kemosabe?”
Kemosabe: “What do you mean the market is up?”
Tonto: “According to the telegraph office the market is hitting new highs on a regular basis.”
Kemosabe: “The total market is not reaching new heights, only one sector, the S&P 500.”
The S&P 500 Index is made up of only 500 US Large Growth stocks. That’s it, US Large Growth; this is hardly indicative of “the market”. The market consists of large cap, small cap, micro cap; value and growth; developed international large, emerging markets, emerging small, and emerging value, to name a few. Additionally, let us not forget about fixed income, cash, T-bills, and bonds.
Broad based, global portfolios hold 19 distinct asset classes. More specifically, asset classes that have been intentionally designed with dissimilar price movements. They are engineered to not be dependent on any specific asset class. This lack of dependency is designed to maximize return for a given level of risk. The goal here is to get an overall market return.
Generally, this strategy is extremely palatable. Unless, of course, the highest performing asset class is the S&P 500 or DOW Jones, both of which are in investor’s face on a daily basis courtesy of the media. This is what clients are dealing with now.
Tonto’s statement of fact is inherently flawed, albeit understandable in the absence of education and understanding of markets.
It is worth remembering that there will always be an asset class that is out performing all of the others. When it is the S&P 500 though, everyone notices. They notice due to the media spotlight and because it makes up a disproportionate percentage allocation of many poorly diversified portfolios, thus making the news sadly relevant.
While some may be inclined to get onto this train of seemingly skyrocketing returns the S&P 500 has offered thus far this year, the wise know that volatility works both ways. The risk is two-fold. Now that the S&P 500 has appreciated, there is a legitimate risk that this ride is over and that any material change to shift resources in this direction may be poorly timed. In other words, the ship may have already sailed. This is the risk of market timing and chasing the market at its very core and the reason actual investor returns frequently do not match fund performance (as evidenced year after year in Dalbar’s Quantitative Analysis of Investor Behavior studies.) Investors see an asset appreciate and then buy (too late). Once in, they frequently get the luxury of the ride down and then sell for a loss. Then they look around for another hot asset, lather, rinse, and repeat.
If investors are doing anything at this point they should be doing the counterintuitive selling of the heavily appreciating assets and buying less appreciated or depreciated assets through systematic rebalancing.
Discipline is not for the weak, but success is the long term reward for its maintenance. An advisor that was able to keep clients disciplined and uninclined to react to current market conditions in 2008 and early 2009 has likely earned their fee for life for that client.
We have committed to coaching our clients through times like these. Education leads to Clarity, Clarity leads to Confidence, and Confidence leads to Peace of Mind.