After spending 30 years as a professional investor on behalf of others, I've grown accustomed to the rhythms of the market. More important, I've grown more attuned to the rhythms of our clients and investors.
Right around this time of a long run bull market when earnings are evasive and markets have been trending upward for 1,399 days without a correction of 10%; we start to get the standard question. Why is my portfolio not generating the returns we expected? (i)(ii)
Again, after 4 consecutive years of not even a hiccup in the market, I would expect clients to become complacent and their expectations extended.
As many of you know, we at Phillips and Company focus on targeting rates of returns for our clients based upon their planning needs. Some clients may need higher rates of return near 7% to not disrupt the lifestyle they are accustomed to when they retire, while others may need a much lower rate of return, based on their needs, of closer to 4.5%.
As you peruse the table above from our friends at Bespoke you can see YTD returns on the far right columns with the red arrows above. The S&P 500 is up a meager 2.31% YTD, the Dow Jones is down -0.74 YTD. (iii)
Combine those returns with some mix of fixed income, circled in red in the lower right, and you can see returns are difficult to attain. In our case, we attempt to globally diversify your assets in an effort to reduce risk further. Those returns have also been muted. While we do have a sliver allocated to Japan and a heavy emphasis on India, it's simply not enough to lift total portfolio returns.
I guess if we were to focus 60% of your portfolio on a single sector like health care and the remaining 40% on intermediate term bonds (7-10 year Treasuries) you would get a combined return of 7.23%. The challenge with making those concentrated bets is our fiduciary duty to you to diversify your assets, reduce your risk, and attempt to generate a targeted rate of return over a longer period than 1 year.
On the other hand we are often asked to review concentrated portfolios, usually in energy and gold. I guess those advisors were selling fear. If you owned some combination of those sectors you would be looking at returns as low as -15.60%.
The simple reason returns in the United States have been muted is due to earnings.
Now just compare the sectors that are generating strong earnings growth (chart immediately above) with the sectors that are generating strongest returns (top chart). (iv)
The good news is we do have some concentrations in our base portfolios with some of those areas. Consumer discretionary, financials and technology to name a few:
Establish a target rate of return, if you don't have one. We can help with this process. If you do have one, collaborate with us on making sure it's correct based upon your savings, spending and time frame. So what should an investor do when faced with a year like 2015?
- Don't chase hot sectors unless earnings support your decision.
- Re-examine the probability of achieving your target returns over the past several years and the coming years. Our target return portfolios have produced the following:
- Think about the maximum drawdown you can face in uncertain times like the recent financial crisis. For example a portfolio of just the hottest sectors today would generate you a loss of 50.92% during the financial crisis vs. a diversified approach.
- Gain an understanding of how we build our portfolios for you and the process we undertake. I've put a PDF link here for your review. I would encourage you to review this with your advisor.
- Don't buy promises that feed your hope or greed with higher fee products.
Remember, fear, frustration, impatience, eagerness, control and avoidance are not reasonable investment strategies. Generally, I see these emotions during this time of the investment cycle.
If you have questions or comments, please let us know as we always appreciate your feedback. You can get in touch with us via Twitter, Facebook, or you can email me directly. For additional information on this, please visit our website.
Tim Phillips, CEO – Phillips & Company
(i) Business Insider, June 15, 2015
(ii) Google Finance, Aug 3, 2015
(iii) Bespoke.com, Aug 3, 2015
(iv) Bloomberg terminal, EA P, SPX May 16 - Aug 15, 2015