By Tim Courtney, Chief Investment Officer
Last week, we discussed how markets work and why real returns require accepting risk. Building on that idea, it is worth spending time on how investors interpret returns and why, even in good years for an overall portfolio, our instincts may lead us to focus on underperformers.
Last year was a pretty good year for stocks. US large companies were up 15% to 20% and International stocks were up 25% to 35%.1 However, US small companies were only up 10% and REITs and MLPs were up less than 10%.1 Further, if we peeled back the wrapper on US large companies as a whole, we would find many negative returns, such as UnitedHealth (-33%), Adobe (-21%), Chipotle (-39%), and Target (-24%).1
We might be tempted to focus on the underperforming investments and consider replacing them. That could be a reasonable action to take in some instances, but in most cases, it is counterproductive for at least two reasons. First, if a diversified portfolio is a goal of an investor, and we think it should be a goal of every investor, their portfolio is going to have underperforming assets. By design and necessity, a diversified portfolio will contain assets that behave differently. No one can have a “Lake Wobegon” diversified portfolio where every asset is above average.
Second, we aren’t able to control when we will receive our compensation for owning an asset. After we buy an asset, millions of other people in the market are involved with the pricing of that investment.2 The market may favor other assets and see less value in your investment for at least a time. This is normal and is something we can’t control. But if the investment provides good exposure to a part of the economy and has a reasonable expected future return, the best course of action is usually to maintain the investment or potentially increase exposure through rebalancing.
There are countless examples of strong assets going through long stretches where the market does not reward them.3 Short-term price movements are not a clear signal. Markets are extremely noisy, especially in the near term.4 A quarter, a year or even a few years is still a short timeframe in the context of an investing lifetime that for most will span several decades. As we’ve noted before, the market is like a voting machine in the short-term where sentiment and popularity hold sway.5 Over longer periods, the market is like a weighing machine that determines the true value of an asset.5
Short-term performance is not a reliable report card. It is often just noise. Drawing strong conclusions from it, whether positive or negative, tends to create false confidence or unnecessary doubt. Investing requires patience and an understanding that many times the best course of action is to stay the course. If you have questions about how investment decisions are being evaluated in your portfolio, your Exencial advisor can help walk through the rationale behind them.
Sources
PAST PERFORMANCE IS NOT AN INDICATION OF FUTURE RETURNS. Information and opinions provided herein reflect the views of the author as of the publication date of this article. Such views and opinions are subject to change at any point and without notice. Some of the information provided herein was obtained from third-party sources believed to be reliable but such information is not guaranteed to be accurate. In addition, the links provided within are for convenience only and the provision of the links does not imply any sponsorship, endorsement, or approval of any of the content. We do not guarantee the content or its accuracy and completeness. The content is being provided for informational purposes only, and nothing within is, or is intended to constitute, investment, tax, or legal advice or a recommendation to buy or sell any types of securities or investments. The author has not taken into account the investment objectives, financial situation, or particular needs of any individual investor. Any forward-looking statements or forecasts are based on assumptions only, and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. Any assumptions and projections displayed are estimates, hypothetical in nature, and meant to serve solely as a guideline. No investment decision should be made based solely on any information provided herein and the author is not responsible for the consequences of any decisions or actions taken as a result of information provided in this book. There is a risk of loss from an investment in securities, including the risk of total loss of principal, which an investor will need to be prepared to bear. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular investor’s financial situation or risk tolerance. Exencial Wealth Advisors, LLC (“EWA”) is an investment adviser registered with the Securities & Exchange Commission (SEC). However, such registration does not imply a certain level of skill or training and no inference to the contrary should be made. EWA may only transact business in those states in which it is registered, notice filed, or qualifies for an exemption or exclusion from registration or notice filing requirements. Complete information about our services and fees is contained in our Form ADV Part 2A (Disclosure Brochure), a copy of which can be obtained at www.adviserinfo.sec.gov or by calling us at 888-478-1971.