Rockbridge Named #81 on CNBC's Top 100 Fee Only Wealth Mgmt Firms List
Jan 18

Three Reasons to Ignore Market Performance

by Craig Buckhout

Capital Market Recap
Equity markets finished the year with a flourish.  In the fourth quarter the S&P 500 was up 10.8%, small stocks (Russell 2000) were even stronger with 16.3% returns, while the international markets (EAFE up 6.7%) were held back by sovereign debt worries and uneven economic growth.

For the year, the story was similar.  All markets had strong positive results, led by small company stocks, real estate, and emerging markets, with returns in the 20-30% range.  Only developed international markets were at or below long-term expected returns.

Periodic Market Performance December 2010

Periodic Market Performance December 2010

Notably, intermediate term bonds lost money in the quarter as interest rates rose, but bonds did well over the year, with returns of 6.6%.  A drop in interest rates increased the value of bonds during the first three quarters of the year, adding significantly to interest payments (yield).  Falling rates have left the intermediate bond index with a yield of 3% or less, meaning rates will need to fall further for bond returns to exceed that level in the short term.

Three Reasons to Ignore Performance When Making Asset Allocation Decisions
Portfolio risk is determined by asset allocation, primarily the basic split between fixed income (cash and bonds) versus equities (small, large, and international stocks).  Risk is inextricably linked to return, but performance data can blur our rational analysis of risk.  Here are three reasons we should try to ignore performance data when determining our asset allocation.

1)  Recency bias – Studies have shown that we tend to give disproportionate prominence to recent observations.  In the early 1990’s we were busy telling people they should be willing to take stock market risk and get over the fact that bonds had outperformed stocks for much of the 70’s and 80’s.  By 2000 everyone wanted to own technology stocks and we were busy telling people they should include bonds in every portfolio.  In 2009 we were back to talking about maintaining a commitment to stocks.

Mark Twain said that history does not repeat itself, but it does rhyme.  We need to be prepared for the rhyme and not base decisions on our recent experience that “feels” like a long-term trend.

2)  The long-term can be very long – Bonds have outperformed stocks over the past ten years.  This is contrary to long-term expectations.  It is unusual but not unprecedented.  In other periods of similarly dismal stock performance, the same thing happened.  Bonds (5-year US bonds) outperformed stocks (S&P 500) for ten-year periods ending 1938-41, again in 1974-83, and now 2008 to the present.

I can’t remember what I had for breakfast, say nothing of how my portfolio was behaving ten years ago.

For most of us, ten years is a very long time, and yet market performance can be very far afield of our expectations over any ten-year period.  On average since 1926, stocks have provided an annual return of 11.9% ($100 grew to $308) and bonds have returned 5.9% ($100 grew to $177).  However, the ten-year period ending May 1959 was the best for stocks, when $100 grew to $697 (compared to $116 for bonds).  These results are in contrast to the period ending February 2009 when $100 invested in stocks ten years earlier was worth only $71 while $100 in bonds grew to $182.  The chart at left shows how much these returns can vary for a particular ten-year period.

3)  It is difficult to make money predicting how the market will react to current conditions – One year ago it seemed inevitable that interest rates would rise and destroy bond values.  It may still happen at some point in the future but the opposite occurred in 2010 – a costly error for anyone acting on that prediction last year.  Similar examples are easy to find.

Conclusion – Ignore performance to make better decisions.  Think of the asset allocation decision in terms of managing risk, and do not let your return expectations (long-term future expectations) be influenced by recency bias, a misperception of what is long term, or the tempting notion that someone can predict how markets will react to our current situation.

About the Author

Craig Buckhout is a Chartered Financial Analyst, and Principal at Rockbridge Investment Management.  “In the early 1990s it became clear to us that ordinary people were going to need help managing their substantial savings, as 401(k) plan assets began to replace pensions as a source of retirement income. After spending the first decade of my career in the world of corporate finance, I was excited to work with clients and apply institutional investment principles to help them achieve their goals.”  Craig holds his BS & MBA from Cornell University, and is a member of the SUNY ESF (College of Environmental Science and Forestry) Foundation Board – Treasurer, CNY Community Foundation – Board Member.
Learn more and/or Contact Craig

You Might Also Like

Other articles filed under News

Market Commentary – April 2019

April 24, 2019
Stock Markets Stocks rebounded nicely. Tech stocks (FANGs – Facebook, Amazon, Netflix, Google) after leading the way down in last year’s fourth quarter (off 22%) led stocks back up (up 23%). A global stock portfolio earned about 12% this quarter...
Continue Reading

Long-Term Disability Considerations

April 22, 2019
Many of us are familiar with insurance for your home, auto and life, but the reality is - we don't often know our specific coverages until we need to make a claim.  Insurance has become so specific it’s worthwhile to...
Continue Reading

Where Is The Value?

April 19, 2019
It’s no secret that since the Financial Crisis value stocks have underperformed growth stocks.   Many theories exist as to why this has happened, none of which can be confirmed as truth.  This begs the question “what does this last decade...
Continue Reading

Life Events to Consider

April 17, 2019
If you’re like most people, you know that planning to achieve your financial goals involves more than just budgeting and saving for retirement. You’ve undoubtedly received financial advice, solicited or otherwise, from some combination of family, friends, coworkers, or even...
Continue Reading

New York State Office of Unclaimed Funds

February 8, 2019
Over the summer, we had a client ask if there was a place to look for existing accounts or funds they or family members may have accumulated and forgotten about over the years. That sparked Julie’s memory of the New...
Continue Reading

‹ Back to Blog Home

getting started is simple

315.671.0588 Schedule a meeting Sign Up for Our Newsletter