Monthly Archives: May 2015

The Problem with the Calendar

Anyone who has done any deep thinking or research about it would agree that the best way to invest is with a long-term perspective.  Investors who use and stick with a well-diversified portfolio with an asset allocation well suited for their risk tolerance tend to achieve better performance than those employing any other approach.  Investors who let their emotions or near-term market actions dictate investment decisions generally underperform those who maintain a long-term, disciplined approach.  Studies show that the longer the investment time horizon, the less variable the annual rates of returns become.

Range of S&P 500 Returns, 1926-2005

Source: Schwab.com

Despite the overwhelming benefits of investing for the long term, most professional investors provide their clients with quarterly reports.  I understand that most people would like to know what’s happening with their portfolios, but I would argue that quarterly updates provide little information that is useful to the average investor.  On the contrary, these reports may provide them sufficient reason to do something that might damage the potential for long-term investment success.

Taking this focus on the short-term to its ridiculous extreme, investors can now track portfolio values (I do it too!) in real time.  They can see not only daily price movements, but can see them by the minute.  The news media dedicated to reporting on capital market matters also encourage a short-term perspective.  “Breaking news” needs to be dramatic, and if a stock is up or down a bunch, it becomes “news” and viewers may feel compelled to “do something” in response to this development.  Short-term traders obviously like this stuff and use daily volatility to their benefit, but most investors should avoid the temptation to consider short-term price moves and/or news as a reason to adjust one’s portfolio.

[Old joke:  How does one make a small fortune day trading?  Start with a large fortune!]

But surely looking at one’s portfolio on an annual basis must be a good idea, right? I have seen studies and even written about the fact that investors who look at/rebalance their portfolios only once a year tend to outperform those who look at and take actions more frequently.  If we can step aside for a minute and realize that an annual accounting for anything is a human construct born out of tradition more than anything else, we might be able to see why even an annual review (12-months, January to December) may be less informative and useful than we think.

Last year is a great example of the perils of making portfolio shifts based on even yearly performance.  We all know that the S&P 500 was the best performing major index in 2014.  This table shows this:

Index

4th Qtr 2014

Year to Date

Trailing 12 Months

Dow Jones Industrial Average

5.2%

10.0%

10.0%

S&P 500

9.7%

13.7%

13.7%

NASDAQ

5.4%

13.4%

13.4%

Russell 2000

9.7%

4.9%

4.9%

MSCI EAFE

-3.5%

-4.5%

-4.5%

MSCI EAFE Small Cap

-2.2%

-4.6%

-4.6%

MSCI Emerging Markets

-4.4%

-1.8%

-1.8%

Barclays Aggregate Bond

1.8%

6.0%

6.0%

Barclays Municipal Bond

1.4%

9.1%

9.1%

Dow Jones Commodities

-11.9%

-18.8%

-18.8%

There are many people out there who concluded that the S&P 500 was the best investment to own simply because of its showing last year.  Most people who concluded this were probably unaware that the last time the S&P 500 stood at the top of this list was 1998 – that is to say, most other indices beat the S&P 500 on an annual basis each of the last 16 years.  Despite this fact, some people who looked at the S&P 500’s performance last year concluded that they should sell their small cap names, international mutual funds and other “underperforming” assets and buy the S&P 500.  This is exactly the kind of behavior that leads to the average investor lagging the market and even average mutual fund returns.

By the end of March, the tables had turned and the S&P 500 swap looked a lot less wonderful than it did in January.  This table shows what happened in Q1:

Index

1st Qtr 2015

Year to Date

Trailing 12 Months

Dow Jones Industrial Average

0.3%

0.3%

10.6%

S&P 500

1.0%

1.0%

12.7%

NASDAQ

3.5%

3.5%

16.7%

Russell 2000

4.3%

4.3%

8.2%

MSCI EAFE

4.9%

4.9%

-0.9%

MSCI EAFE Small Cap

5.6%

5.6%

-2.6%

MSCI Emerging Markets

1.9%

1.9%

-2.0%

Barclays Aggregate Bond

1.6%

1.6%

5.7%

Barclays Municipal Bond

1.0%

1.0%

6.6%

Dow Jones Commodities

-6.0%

-6.0%

-27.0%

The S&P 500 registered lower returns than nearly everything in Q1.  So what does the investor who made the switch in January do now?  This is the heart of the problem.  Looking at performance even annually can lead to common investment mistakes.

So what’s an investor to do?  What time frame measure is truly meaningful?  A recent white paper by the investment management company Invesco attempts to answer this question (click here for the full report – https://www.invesco.com/portal/site/us/financial-professional/active-passive-investing/).  This report suggests that the best time frame in which to assess the quality of a mutual fund, investment manager or one’s own investment approach is a complete cycle – that is from peak to peak and trough to trough.  Market tops and bottoms do not fall into neat, discrete annual packages.  They happen when they will.  How a portfolio manager does in a complete cycle can show the real value added of his/her approach to investing.

The paper goes on to suggest that actively managed portfolios tend to outperform passive investments when measured over complete cycles.  This is in stark contrast to the suggestion that 1) half of all mutual funds underperform their benchmarks and 2) you can’t beat the market.

Therefore what?

The complexity of the capital markets makes simple answers hard to find.  My purpose in penning this note was to highlight a tendency I have observed in people with investment portfolios.  “Don’t look at your quarterly statement” is probably not a great suggestion.  I guess if I had to offer some advice to those who find themselves chasing performance and always making changes in their portfolios at the wrong time I would circle back to where I started – invest with a long-term horizon, find an investment style/approach/manager and asset allocation that fits well with your risk tolerance and personality and then stick with it.  I believe that this patient approach to investing will pay big dividends in the long run.