What once was, won't be, and may soon cycle back. Rather than trying to chase returns, develop a diversification strategy that includes the main sources of return and let all those cycles compete within your portfolio; and also rebalance.
Focusing on Short-Term Returns can be Hazardous to your Wealth
1. INSIGHTS
Focusing on Short-Term Returns can be
Hazardous for your Wealth
Imagine investing in an asset that has increased
in value by 14.8% per year over the last three
years. This asset also had a positive return when
U.S. stocks fell last September.
Can you guess what asset class this was?
The answer: International stocks in their own
local currency returns (represented by the MSCI
EAFE NR LCL).
So why do so many investors feel like
international stocks have not performed well
recently?
Changes in currency:
The 14.8% three-year annualized return is
the performance on the stock markets
around the world in their own relative
currencies. However when translated back
into U.S. Dollars, that return falls from 14.8%
to 9.7%.
The 5% difference in returns can be
attributed to a strengthening dollar.
The U.S. Dollar strengthened by nearly 7% in
the 3rd quarter of 2014 and has gained nearly
20% over the previous three years, creating a
strong headwind for International returns
when translated back into U.S. Dollars.1
Economic conditions and forecasts for future
interest rates have risen faster in the U.S.
compared to the rest of the world, and as a
result the U.S. Dollar has strengthened.
The comparison with U.S. stock performance:
Over this same three-year period the S&P
500 returned a resounding 19.8% per year.
1
2014 Morningstar Direct, Federal Reserve Bank of St.
Louis database
For the year through October the S&P 500
was up 11.0%, compared to an MSCI EAFE
NR USD return of -5.1%
The returns on large cap U.S. companies most
investors are familiar with are much more
visible than International companies.
Given the strength of the U.S. Dollar and the
lackluster performance of International stocks
year to date, should investors shift to a heavy
home bias in their portfolios?
Not if history is any guide.
A large benefit of investing in a globally
diversified portfolio is that different asset classes
will outperform at different times. For example
the Dow Jones US Select REIT index lagged most
other stocks last year, returning just 1.2%
compared to the S&P 500 2013 return of 32.4%.
Yet in 2014, REITs have outperformed the S&P
500 by 15%. Investors who rebalanced or added
money into an account last year were able to buy
additional REIT shares at lower prices and
participate in the large gains seen this year.
While International investments have
underperformed relative to domestic stocks in
recent periods, there are many periods when the
opposite is true, such as the mid-2000s or 1970s.
We don’t know which asset classes will do best in
the coming month, quarter or year. But we do
know that investors have been well served by
having a globally diversified portfolio which
maintains exposure to numerous asset classes
through the ups and downs they will all
inevitably face.
Source: Morningstar Direct 2014. Market segment (Index
representation) as follows: U.S. Large Cap (S&P 500 Index),
U.S. Value Stocks (Russell 1000 Value Index), U.S. Small
Company Stocks (Russell 2000 Index), U.S. Real Estate
2. INSIGHTS
Focusing on Short-Term Returns can be
Hazardous for your Wealth
Market (Dow Jones U.S. Select REIT Index), International
Developed Value (MSCI World Ex USA Value Index (net div.)),
International Small (MSCI World Ex USA Small (net div.)),
Emerging Markets (MSCI Emerging Markets Index (net div)),
Global Bonds (Citi WGBI 1-5 Yr Hdg USD), US Bonds (BofA
ML Corp & Govt 1-3 Yr TR).
Indexes are unmanaged baskets of securities that are not
available for direct investment by investors. Index performance
does not reflect the expenses associated with the management
of an actual portfolio.
Diversification neither assures a profit nor guarantees against
loss in a declining market.
Past performance is not a guarantee of future results. All
investments involve risk, including loss of principal. Foreign
securities involve additional risks, including foreign currency
changes, political risks, foreign taxes, and different methods of
accounting and financial reporting.
Stock investing involves risks, including increased volatility (up
and down movement in the value of your assets) and loss of
principal. Investors with time horizons of less than five years
should consider minimizing or avoiding investing in common
stocks. Real estate securities funds are subject to changes in
economic conditions, credit risk and interest rate fluctuations.