October 12 2018 Market Update

Why Isn’t My Portfolio Beating the Market?

Equity markets have been strong this year: the S&P 500 was up 8.99% for the year through September 28,^[1] and the MSCI World Index, which tracks equity performance in 23 developed countries, returned 5.89% in the same period.^[2] The MSCI EAFE Index, which captures 21 developed markets excluding the US and Canada, fell 1.43% through September 28.^[3]

As a result, we’ve heard this question a few times: if the markets are doing so well, why isn’t my portfolio up that much, or even more?

The short answer is that your portfolio is diversified, which means you won’t capture the full percentage return of equity markets – nor the full loss during a downturn. But there’s more to it than that.

Equity markets have been on a tear for some time now, and it’s our position that letting enthusiasm and dollar signs influence our approach to investment management, risk monitoring, and discipline would be a mistake.

The 3.3% drop in the S&P 500 on October 10, 2018^[4] provided a demonstration of why we maintain that view. Volatility can come at any time, and in our opinion it’s the disciplined, emotion-free portfolios which make it through.

Here are some of the most common questions we’ve encountered – followed by our views on how to handle a market like this one.

“What if it’s different this time?”

The tech sector has been a significant driver of the market’s run in the past few years, both in terms of their size within the S&P 500 index and the returns they’ve generated.

It isn’t unusual for a handful of companies to represent a significant share of the S&P 500, but what is unusual is that the top firms are almost completely undiversified: four out of five are technology companies. ^[5]

In other words, there is something different about performance this time – especially because these few companies have performed so much more spectacularly than the index as a whole.^[6]

Through early July, when the S&P 500 was rising even more rapidly than it did in the third quarter, just three companies (Amazon, Netflix, and Microsoft) were responsible for 71% of the index’s 2018 returns.^[7]  

Just as we wouldn’t advise you to pile your life savings into a handful of technology stocks, we also wouldn’t advise pouring capital into an equity index in the hopes of capturing more returns from that same handful of undiversified companies. Especially  if your goal is long-term wealth preservation.

“But what if I miss all the upside?”

Because of our risk-aware approach, most of our portfolios are not up as much as the S&P 500. This can generate feelings of missing out since the index has done so well.

But it’s important to remember that the price of higher average returns is higher volatility. Given the risk tolerance, time horizon, and practical requirements that most of our clients have for their assets, it is not a risk we are willing to take in most cases.

If and when the bull run reverses or slows down (which is, in our view, inevitable as interest rates rise and investors de-risk by moving into bonds), we want our clients to be poised for the transition, rather than get caught with too much exposure to the downside as a result of over-enthusiasm for the upside.

“Can’t we just sell when the market turns?”

If you’ve been with our firm for a while, you know how we feel about market timing. It’s a nice thought that you’ll be able to spot the top of the market and sell accordingly – just as it’s a nice thought that you’d be able to find the bottom and buy up all risk assets in the perfect moment.

In practice, market timing is not an effective strategy.

Countless people of high intelligence, educational pedigree, and broad experience have attempted it, using everything from psychology to philosophy to computer programs. It’s our view that the results are almost always the same: it’s possible to get lucky, but it’s nearly impossible to outperform the markets through market timing over the long-run.

The academic literature bears this out.

One recent study found that even just market timing between stocks and bonds is likely to deliver below-median returns, at best – and that’s before accounting for costs.^[8] Other work has shown that the performance of market-timing is “highly overstated”^[9] and that transaction costs and high expenses make these strategies less likely to succeed.^[10]

Our View: Don’t Chase Performance, Pursue Results

At JSF Financial, we don’t chase performance, we chase results for our clients – an approach that goes far beyond benchmarked returns.

These are some of the cornerstones of the JSF Financial approach to investment management and why they work over the long haul.

Smart and steady – a disciplined approach to buying

While every successful investor will repeat the refrain “buy low, sell high,” implementing this philosophy is extremely difficult. That’s because we as humans tend to react to the emotion of the crowd – when the markets are riding to new record-breaking highs, we want in.

But letting your emotions drive your investment strategy is a recipe for buying at the top of the market and selling at the bottom.

Having a well-defined plan in place helps avoid emotional decision-making, which is extremely costly for most investors. A number of studies on individual investor performance support this view,^[11] and our experience has confirmed it.

Preserve wealth, don’t get greedy with it – a disciplined approach to diversification

Similarly, your asset allocation itself should be designed to reap some of the upsides of bull runs without sacrificing the ability to withstand tougher times.

The reason we don’t chase returns when markets are rising is simple: the cost of going in and out of the market in the hopes that you’ll do a little better can dramatically reduce your chances of making money over the long haul.^[12]

Your asset allocation exists to provide you with a degree of predictability over a period of time – and generally speaking, for those with an allocation to equity markets, we’re talking about decades rather than years. For those planning a retirement, endowment, or multi-generational strategy, our planning process is designed to deliver results for decades rather than years.

The only way those long-term investment plans can do their jobs is through discipline

Maintaining discipline makes it much easier to reap the benefits of diversification. On the other hand, moving in and out of strategies means you’re that much more likely to miss market rebounds after a sell-off – or have too many eggs in one basket during a sudden decline.

The price of trying to beat the market is too high – a disciplined approach to cost

It is our belief that when the markets turn – and they always have – it will be the disciplined, emotion-free portfolios which make it through. Not the ones grounded in untested algorithms and computer programs, not the ones that reallocated to risk assets to pursue returns, and not the ones that trade repeatedly in the hopes of finding the golden goose.

Resilience Over Short-Term Performance

Our process is what we think of as robust, resilient, tactical and long-term wealth management. It might not feel very exciting. But we’re not in the business of adding excitement to your financial life. We’re in the business of removing excitement – and providing predictability instead.

Please give us a call or schedule an appointment if you’d like to talk about your portfolio’s performance. We’re here to answer your questions and discuss your strategy at any time, and we welcome the chance to talk further about our philosophy and your needs.

JSF Financial