By Jon Yankee, CFP®
The turmoil this summer in the investment markets
might cause one to think that people have lost money this year in U.S.
stocks. But in fact, most of the U.S. indices are sitting on plus twenty
percent gains for the year.
The rest of the world is not doing as well.
Emerging Markets are having a horrible year. Looking over alternative
asset classes, real estate investments are about flat for the year, and
commodities are, like emerging markets, are down big this year. Add those
asset classes to the fixed income piece of your portfolio, which is also down,
and you have a year that is not too pleasant for a diversified portfolio.
This is the kind of market environment that many
professional advisors least enjoy – for a variety of reasons. First, the
turmoil over the summer makes it clear that investors are making investment
decisions – and moving market prices – based on emotions rather than
logic. The initial panic following Fed Chairman Ben Bernanke's comments
during the summer about ending its QE3 stimulus program seems to have
subsided. But when market values drop precipitously based on a single
speech about a hypothetical Fed action that would only be taken due to improved
fundamentals, you know that investors are not thinking rationally.
The other reason professional advisors dislike
the current state of the markets is the way diversification looks right now.
Whenever U.S. stocks are delivering positive returns while almost everything
else – emerging market stocks, bonds, real estate, commodities, and all the
other pieces of a prudently constructed portfolio – are going in the tank,
investors will ask questions like: "The S&P 500 is up 20% so far this
year, but my portfolio is only up 6%. What are you doing wrong?"
The truth is, no professional can pick the one
winning asset out of the myriad of options every year (or half year), and no
prudent professional would ever try. There will always be one asset that
returns more than the others, and that winning asset will always be
different. Yet American investors hear about the S&P 500 (and the
Dow, and other U.S. large stock indices) on the nightly news, so they are most
likely to question the competence (or sanity) of their advisor when the U.S.
stock markets are booming and everything else is lagging – exactly the
situation we have today.
As most of our clients know, this is the “frame
of reference risk” that we discuss often…our client portfolios are very
different than most peoples’ context for conversations or current events.
It is the first time since 1998 that we have had such an investment
market. Diversification works…even if you don’t want it to work.
Eventually, some other investment will take the
lead, diversified portfolios will look better relative to the U.S. stock
indices, and professional advisors will look like geniuses. That, too,
will be a naive view of the situation, but it will be a more pleasant one for
those of us who believe in the long-term value of diversification.
