Q3 Perspective: The Discipline of Diversity

Posted at 9th October 2018

We hope that you are enjoying this Fall season. The holidays are right around the corner!  Please find below our update on the markets and a discussion about two important investing principles.

STRONG MARKET PERFORMANCE CONTINUES – AT LEAST FOR U.S. STOCKS

A strong third quarter for US stocks has added to solid performance numbers for the major US Stock Indices. Here are 2018 year to date performance numbers for the major U.S. indexes.  

  • The Dow Jones Industrial Average: +6.99%
  • The S&P 500: +7.93%
  • The Russell 2000: +6.29%

Source: Morningstar | 2018 year to date figures as of 10/3/2018
 

Solid corporate earnings have supported these strong U.S. performance numbers, along with decreasing jobless claims, increased wage growth, and relatively low interest rates.
 

MOST OTHER ASSET CLASSES CONTINUE TO STRUGGLE

The prospects of global trade wars, renewed tensions around the Brexit saga, and the Fed continuing to increase interest rates have all contributed to less than stellar returns outside of US stocks so far for 2018.

  • US Fixed Income (Bonds):  Barclay’s US AGG Index:  -2.53%
  • International Developed Stocks:  MSCI EAFE:  -3.30%
  • International Emerging Stocks:  MSCI EM: -11.54%
  • US Real Estate: MSCI US REIT:  -0.80%

Sources:  Morningstar and MSCI | 2018 year to date figures as of 10/3/2018

 

THE DISCIPLINE OF DIVERSITY

You can’t go very long when discussing investment strategy before the concept of diversity or phrases like “don’t put all of your eggs in one basket” and “make sure to spread your risk around” are mentioned.

LifeGuide’s own investing principle #2 is “Maintain meaningful diversity.” In fact, this principle dates back over 2,900 years. Recognized by many as the wisest man of his time, Solomon (who is thought to be the author) wrote in the book of Ecclesiastes “Invest in seven ventures, yes, in eight; you do not know what disaster may come upon the land.” (Chapter 11 verse 2)  He then continued in verse 6, “For you do not know which will succeed, whether this or that, or whether both will do equally well.” Investing in a variety of asset classes guards against the negative effects of being exposed to a single set of economic factors. The concept of diversity is effective and comforting when things go south in any one given asset class by cushioning the overall negative impact on a portfolio.

However, the same diversity concept can be the cause of confusion, and even a bit of frustration, when you hear about a particular asset class doing really well and don’t see it reflected in your portfolio balance. This is especially true when US stocks are doing well. US stocks is the asset class most heavily reported and most often referred to as “the market” by financial and political media outlets. It is during times like these when sticking to a principled investment strategy can require some resolve.

A diversified portfolio’s overall performance is always going to be lower than its best performing holding and higher than its worst performing holding. A portfolio’s overall return is going to be the weighted average of the performance of all its positions. 
 

THE GOOD NEWS – REBALANCING IS A POWERFUL TOOL

Another investing term, “Rebalancing,” works hand in hand with the concept of diversification. Rebalancing also dovetails with LifeGuide’s Investment Principle #3: “Be contrarian”. Rebalancing is the process of selling holdings that have become overweight in a portfolio and buying positions that have become underweight. Positions tend to become overweight from performing better than the others, with the inverse being true for positions that tend to become underweight. Following this principle systematically causes us to sell high and buy low. Often, investors make emotionally-based decisions and chase hot markets, leading them to buy high. Our dynamic rebalancing process reviews portfolios weekly to determine which positions to buy or sell based on pre-defined allocation drift tolerances. Said another way, we look to take winnings off the table and buy the positions that are out of favor at a discount (for example, that has recently resulted in selling out of portions of US stocks and buying into international stocks).

 

           
Source: Kitces.com


GOOD INVESTORS LEARN FROM GOOD INVESTORS


There is much research and analysis that supports the power of rebalancing particularly when taking regular withdraws from a portfolio.  The chart above shows the effects of a 4% withdrawal rate with rebalancing (top) and without rebalancing (bottom). The top graph only pulls withdrawals from whichever asset class happens to be high at the time; whereas the bottom graph also then rebalances back to its desired allocation after the withdrawal.

Of course, no technique can guarantee against losses. There will be times when all or most asset classes perform poorly, which will result in negative overall portfolio performance. In times like these, it is crucial to have an investment strategy that has been constructed in the context of your overall LifePlan, which has planned for unexpected market downturns.  Proper planning will help you stick to your investment strategy and avoid costly mistakes.  Taking some risk is required to be able to achieve any significant real return after inflation.  Otherwise, there would be no reason to invest in anything that wasn’t relatively risk-free such as savings accounts or CDs at your bank.
 

We believe that to be good investors you need to study good investors and learn from what they do. One of the voices that we listen to is Dr. David Swenson, the Chief Investment Officer of Yale University’s endowment fund. In his words, “Sensible investors pursue diversification as a policy to reduce risk not as a tactic to chase performance. By following a disciplined policy of maintaining a well-diversified set of portfolio exposures, regardless of market zigs and zags, investors establish the conditions for long-run success.” Avoiding the urge to chase returns based on current market conditions isn’t always the easiest policy to follow, but vast research, data, and industry leaders posit that sticking to a diversified investment strategy offers the best chance of long-term success.

Rest assured, your LifeGuide team is focused on your long-term success and helping you be a great investor through all kinds of market environments.

LifeGuide Financial Advisors, LLC (“LifeGuide Financial”) is a registered investment advisor within the U.S. Securities and Exchange Commission. LifeGuide Financial provides investment advisory and related services for clients nationally. LifeGuide Financial will maintain all applicable registration and licenses.
 

The information provided does not constitute investment advice and it should not be relied on as such. It does not take into account any investor’s particular investment objectives, strategies, tax status, or investment horizon. All material has been obtained from sources believed to be reliable. There is no representation or warranty as to the accuracy of the information, and “LifeGuide Financial Advisors, LLC” shall have no liability for decisions based on such information.

View and opinions are subject to change at any time based on market and other conditions.

Investing involves risk including the risk of loss of principal.

Past performance is not indicative of future results.

Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss, and the reinvestment of dividends and other income.

Diversification does not ensure a profit or guarantee against loss.