Investors are always very interested in the returns they get on their portfolios. But as Will Rogers famously remarked, the return OF his money was more important to him than the return ON his money.
Millions of investors may be feeling the same way these days, waiting for their portfolios to return in value to their high point, which for most people occurred in the fall of 2007. How fast a portfolio bounces back from adversity is an important measure of the risk of that portfolio.
We asked Larry Katz, our director of research, to plot the declines and (so far) partial recoveries of five diversified portfolios that we describe in our table "Fine tuning your asset allocation" plus the Standard & Poor's 500 Index. In each case, we wanted to see what happened after the high point, the beginning of October 2007, through the end of November 2009, giving us a 26-month market snapshot.
The graph below uses that time frame to track the values of hypothetical worldwide portfolios with equity allocations of 40 percent, 50 percent, 60 percent and 70 percent, which represent the risk profiles taken by most of our clients, as well as a 100-percent-equity diversified portfolio and the S&P 500 Index.
You’ll see that the interim peaks and valleys all occurred at about the same times. But some portfolios fell further and faster than others. And some recovered faster than others.
Six portfolios compared: Oct. 1, 2007 through Nov. 30, 2009
Each hypothetical portfolio started with $100,000 and was rebalanced monthly. No money was added or withdrawn. While these don't duplicate any real-world portfolios, the size and speed of their declines and recoveries are similar to those of many accounts that we manage for clients.
The graph is based on the assumption that investors stayed the course through the tough times of 2008 and 2009 – something that wasn’t easy for a lot of people.
You can see at a glance why some investors may be feeling more stress right now than others. The all-equity diversified portfolio, for example, fell the farthest from its high, hitting a low month-end value of $41,363 (a drop of nearly 59 percent) last February. In the next nine months, March through November, it bounced back to $70,276, a gain of about 70 percent.
Pains and gains
As you would expect, the decline in value of each of the five diversified portfolios was directly correlated with how much equity it contained. In the bad times, more equity meant more pain.
Just as important, though maybe not quite so immediately obvious in the graph, the portfolios with more equities bounced back at a faster rate this year. In March through November, the 70 percent equity portfolio gained 48 percent, compared with a 28 percent gain in the 40 percent equity portfolio. In the good times, more equity meant more gain.
The graph shows only one snapshot in time. We don’t believe these 26 months are necessarily typical nor that they in any way predict the future. We chose that period in order to illustrate the “break-even” psychological struggle that we believe is on many investors’ minds these days.
You may look at this graph, think about these numbers and conclude that you should minimize your exposure to equities. But for many people, that could be a costly mistake. The long-term bias of the stock market is upward, and during good times, more equity exposure is likely to lead to higher returns.
Getting your asset allocation right requires a delicate balance that should be based on your emotional makeup and all your circumstances. If you invest too heavily in equities, you could sustain losses that you will have a hard time making up, or you could lose your confidence and bail out of the market at a bad time. On the other hand, if you invest too heavily in fixed-income funds, your assets and income might not keep up with inflation.
These are challenging issues, and some investors make their asset allocation decisions too casually. Many investors could benefit from having a professional advisor help them through this tricky territory.
Paul Merriman is founder of Merriman.
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This document contains hypothetical results. Although we have done our best to present this information fairly, hypothetical performance is still potentially misleading. Hypothetical data does not represent actual performance and should not be interpreted as an indication of actual performance. This data is based on transactions that were not made. Instead, the trades were simulated, based on knowledge that was available only after the fact and thus with the benefit of hindsight. Results do not include the impact of taxes, if any. Past returns are not indicative of future results. The content in this article is intended for educational and informational purposes only and not as investment advice or an offer or recommendation to buy or sell an investment product. Any investment decision made carries risk including the risk of financial loss and is ultimately the responsibility of the individual who should consult beforehand with a financial advisor.
Data Sources: The data presented above is based on publicly reported returns of Dimensional Fund Advisors asset class funds and other securities detailed below. The data assumes reinvestment of dividends and interest.
Equities
• U.S. equity allocation: 20% each in DFLCX, DFLVX, DFSCX, DFSVX and DFREX.
• International equity allocations: 20% each in DFALX, DFIVX, DFISX, DISVX and DFCEX.
S&P 500 Index provided by Standard & Poor’s Index Services Group, through DFA.
Fixed income
DFA TIPS DIPSX
DFA Intermediate Government Bonds DFIGX
Vanguard Short-Term Treasuries VFISX, Morningstar.
• Bond Allocation: 50% in Intermediate Term Government, 30% in Short-term Treasuries and 20% in TIPS
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