Just a few weeks ago, there was fear that the world was falling apart. Markets were expected to have a significant correction and budget cuts were set to put us into another recession. But today, even with North Korea’s finger on the missile launch button, we’ve somehow survived. The markets keep chugging along and have shrugged off the daily headlines.
When I ask a client which factor is most important to his or her portfolio performance—stock picking, market timing or asset allocation—almost always, he or she will tell me market timing and stock picks. Years ago when I first entered the investment management world, I would have said the same thing, because I started with a firm that believed in active management (that is, marketing timing and stock picks). It’s easy to come to that conclusion. Simply pick up one of the many financial publications out there, or just turn on the TV. Headlines have driven investor behavior for decades. They often proclaim, “Don’t overlook the next big stock winners” or, “This is how I doubled my money.” I mention this because over 90% of one’s returns are driven by asset allocation. Surprised? You shouldn’t be. More than 70% of all active managers historically underperform their benchmark and the strong returns of 2012 did not make for a strong year for active management, as the majority of equity managers across all but two categories underperformed their respective benchmarks. Furthermore, the volatility of the last five years has caused nearly 27% of domestic equity funds, 23% of international equity funds and 18% of fixed income funds to merge or liquidate.
I recently attended an introductory conference at Dimensional Fund Advisors (DFA) and listened to a great presentation by DFA’s Weston Wellington. No, he didn’t try to predict the future or tell us what to expect in 2013. Wellington gave his widely popular presentation, “Investment Pornography.” The presentation focused on dozens of cover pages from publications such as Forbes, Worth, Money, Barrons and Time, all of which created some sense of urgency or suggested impending doom. The quick moral of the presentation was that if an investor had acted based on these cover stories, he or she would have deprived themselves of future gains.
To see how this has played out before, let’s look back to a period that was the best decade of market returns, the roaring 90’s. This decade created immense wealth for investors in the market, but only if they were ignoring all the hype produced by the headlines. In late 1990, we had just entered the Gulf War and headlines often warned investors that the U.S. was in turmoil and they should get out of the markets. Unfortunately, for those investors who followed the advice touted in the headlines and sold their stocks, they would have missed the +26% return of 1991, which was followed by two more consecutive years of positive returns. In 1994 the markets did settle down and ended the year with a small correction. However, 1995 started a period of five consecutive years of tremendous market performance, with the worst performing year giving you a measly +19.54%. The media loves to write about doom and gloom. So, even when we enjoy a market upswing, the headlines start predicting the next downturn.
There have been times when it appeared that the prognosticators were correct. In 1998, when a very harsh intra-year market correction wiped out a 16% market gain through July of that year, it looked like the media had finally gotten it right and the market highs had come and gone. The August 1998 cover of Money read “World Meltdown” but, only months later, their cover read, “Everyone’s getting rich.” Despite average intra-year declines of 14.7%, the markets have produced positive annual returns in 25 of the last 33 years. These headlines may seem eerily similar to what we are seeing today.
The key take-away here is this: if you have that desire to watch the experts on TV or read their articles, find a way to put your head down and ignore their advice. Do not worry about the stock pick of the day or timing the next market downturn. Let your financial advisor do the worrying. Simply allow your disciplined and well-diversified investment strategy do its job. Your portfolio will thank you in the long run.