Performance Driver Review
Returns across most asset classes this year have been nothing short of abysmal. The twin performance drags of both stock and bond markets down significantly over the same period have inflicted pain on even the most conservative of asset allocations.
Commonly, investors lose their discipline during times of pain, running from their appropriate mix of stocks and bonds to a portfolio full of cash. These emotional decisions generally lead to sub-optimal long-term results. Despite a normal 60/40 stock/bond portfolio historically returning 6.4% per year, the average investor’s portfolio typically only returns 2.6% over the same period due to emotional market-timing decisions.1
Considering the impossibility of timing the market, it’s prudent to focus on the things investors know for sure as opposed to the unknowns.
The primary fact of concern is that the S&P 500 is roughly 25% off of its high as of the end of 3Q22. Importantly, this is just a point-in-time piece of data. It tells investors nothing about where markets will go from here. To illustrate, examine two other >20% selloffs in history…
- The date is March 12, 2001. Y2K has past and the Dotcom Bubble has burst. Markets are down 20% from their peak in March of 2000. Little did investors know that this decline would mark the beginning of three years of negative stock market returns (2000, 2001, 2002).
- The date is December 24, 2018. The Fed is raising rates and trade tensions are high. Markets are down 20% from their peak in September of 2018. Little did investors know that this decline would mark the beginning of a prolific 44% rise in the stock market over 14 months.
These are two distinct scenarios with very different outcomes which both started from a seemingly treacherous selloff. All of this to say that making decisions based off 2022’s year-to-date market performance or what “could be” over the next two to three years is a fool’s errand. Instead, investors must make decisions based off the things they know for certain…
Bond yields are the highest they have been in over a decade.
Action by the Federal Reserve as well as several quarters of hot inflation prints have pushed up bond yields across the yield curve with the 10Y Treasury yield at 3.83%, its highest since 2010, and the 2Y Treasury yield at 4.28%, its highest since 2007.
While it is painful getting back to this yield level, it is notable that the starting point for retirement and legacy planning in this environment is substantially more sanguine than it was at the end of 2021. The portfolio risk required of an investor to meet their long-term goals is now significantly less than it was just 10 months ago.
More specifically, fixed income portfolios, for the first time in several years, have very attractive total return prospects in this environment. Bond issues across the curve are trading at attractive prices, and a laddered approach to fixed income investing balances interest rate risk and reinvestment risk.
Time in the market is greater than timing the market.
Predicting market tops and bottoms is one of the most difficult things in the investing industry. Making this strategy even more risky is the cost of missing just a few good days. When markets begin to recover, the swings are often significant and aggressive. Historically, missing just the 10 best market days over a 20-year period has reduced returns by over 3% per year, an incredible reduction in long-term wealth potential.2
When it comes to market timing, Peter Lynch said it best: “Far more money has been lost by investors preparing for corrections or trying to anticipate corrections than has been lost in the corrections themselves.” Trying to hit highs or lows is destructive by nature. Staying invested over the long run gives an investor’s money its best chance to compound.
Asset allocation is the greatest determinant of risk.
The most important market concept with respect to risk is often all but forgotten in times of strife. It is an investor’s asset allocation that determines both his or her portfolio growth potential and the volatility that portfolio will exhibit overtime. From a quantifiable standpoint, nearly 75% of a portfolio’s volatility comes from asset allocation with the balance coming from market timing and security selection.3
A Portfolio Manager must work carefully with a client to understand his or her return objectives, risk tolerance and other unique considerations. This careful and calculated conversation between advisor and advisee ensures that sharp portfolio moves, although painful, are within expectations and do not impair maximum wealth potential.
Downturns are painful and uncertainty is scary, but it is of the utmost importance that investors understand the journey to grow one’s wealth comes with many fits and starts. Patient money navigates the tumult and emerges on the other side with steady, methodic growth.
As a WoodTrust client, you can rest assured your asset allocation and investment portfolios are tailored to your specific situation and considerations. Your service team works tirelessly every day to ensure your portfolios are invested among quality companies and with quality investment managers. We need not dwell on what tomorrow may bring to take advantage of what we know today. As always, we thank you for your trust and look forward to our meetings with you in the near future.
160/40 Portfolio: A balanced portfolio with 60% invested in the S&P 500 Index and 40% invested in high-quality U.S. fixed income, rebalanced annually. Average investor return is based on an analysis by Dalbar Inc., which utilizes the net of aggregate mutual fund sales, redemptions and exchanges each month as a measure of investor behavior. Years studied: 1998-2017
2Source: Devis Funds – Years studied: 1992-2011
3Source: Devis Funds – 192 managers from eVestment Alliance’s large cap universe whose 10-year average annualized performance ranked in the top quartile from January 1, 2002–December 31, 2011.