As investors, we’ve all heard, “don’t put all of your eggs in one basket.” But as human beings, we sometimes have a hard time resisting the temptation. Think back to the late 90s when everyone was making money in the stock market. The average Joe became a day trader, your neighbor was full of hot stock tips, and your cousin was getting rich quick buying stock in Cisco and Nokia. It was hard not to jump on that bandwagon, but we all know how that turned out in the recession of 2000-2002.
Fast forward a few years to after the tech bubble burst. All I heard from clients then was, “I just want to invest all of my money into my house, because that is the only thing going up in value.” Cash-out re-financings and home equity lines of credit to do home improvements quickly became the norm. Home prices were rising in the double digits from 2000-2006.
It was irrational exuberance all over again.
So, what should a prudent investor do? It’s simple, but not always easy. Diversify! What does this mean? Merriam-Webster’s definition is, “to change (something) so that it has more different kinds of people or things.” The hard part about this is that it means buying asset classes that are currently out of favor (i.e., types of investments that have lost value in the recent past).
Diversify Your Assets
Diversification tames the roller coaster ride. If you own a mix of several different types of investments, it’s almost certain that they’ll never all be down at once. This is the beauty of negative or less than perfect correlation—having assets that react differently to the same set of stimuli. For example, take a look at the light blue boxes on the chart below that represent a “Moderate Benchmark” of 60% stocks/40% bonds, representing a globally diversified mix of small and large cap, domestic and international stocks as well as bonds of various sectors, credit quality, countries and maturities. Its historical returns from 1999-2013 were always somewhere in the middle of the pack. If this chart went back even further in history, this would still be the case.
Of course, we’d all like to only own the asset classes on the top of the chart during any given period of time. But, history has shown us over and over again that it is not possible to correctly and consistently predict what will outperform when. If someone had figured that out by now, we’d all know about it.
Find the Right Level of Investment Risk
In conclusion, if you haven’t done so already, evaluate what is the right level of investment risk for you. If needed, use a questionnaire to help gauge your personal level of risk tolerance or consult a financial advisor for guidance. Then, with the help of your advisor, create a portfolio with a mix of stocks, bonds, and possibly alternative investments such as real estate, commodities, hedge funds, etc. that matches your risk tolerance and time frame. Diversify into several sub-asset classes within stocks, bonds, and alternatives (large/small companies, domestic/international, growth/value, high credit quality/high yield, etc.). Rebalance when necessary to stay close to your target allocation. Unless your personal situation warrants a change, stick with it. It’s not rocket science and it won’t sell many copies of Money magazine, but if you’re disciplined enough to save consistently, diversify properly and stay the course, it just might make you rich one day!
Past performance is not indicative of future results. Actual investors may experience materially different returns than those of any index or benchmark, and it should not be assumed that future performance will be profitable or that it will equal the performance of any index or benchmark on this table. Index or benchmark performance is used to provide an approximation of the returns of the applicable asset class. It is not possible to invest in an index. All index and benchmark performance results have been compiled by Hewins from sources deemed to be reliable but have not been independently verified. The hypothetical benchmark returns reflect the reinvestment of dividends and other earnings, but neither the index returns nor the benchmark returns reflect the deduction of transaction fees, custodial charges, or the deduction of investment management fees, the incurrence of which would have the effect of decreasing indicated historical performance results. Returns do not reflect any corresponding impact of taxes on investment returns. The volatility of an index may be materially different from the volatility of any portfolio.
Moderate Benchmark and Bond Benchmarks
The returns for the Moderate Benchmark and Bond Benchmark represent results for broadly diversified index-based asset allocations during the corresponding time period. The Moderate Benchmark is a broadly diversified 60% equity/40% fixed income allocation. The Bond Benchmark is a broadly diversified fixed income allocation. Both benchmarks are comprised of indices deemed appropriate for each sub-asset class within the allocation and are subject to revision at any time. The historical Moderate Benchmark and Bond Benchmark performance results are provided exclusively for comparison purposes. It should not be assumed that any Hewins account holdings will correspond directly to any such comparative allocations. The performance results for the Moderate Benchmark and Bond Benchmark reflect monthly rebalancing. That is, each month, regardless of performance, the allocation to each investment style is adjusted to reflect the model allocation. The results reflect hypothetical, back-tested results of the Moderate Benchmark and Bond Benchmark that were achieved by means of the retroactive application of the allocation, and, as such, the corresponding hypothetical results have inherent limitations, including: (1) the results do not reflect the results of actual trading, but were achieved by means of the retroactive application of the Moderate Benchmark and Bond Benchmark allocations, certain aspects of which may have been designed with the benefit of hindsight; (2) back tested performance may not reflect the impact that any material market or economic factors might have had on the allocation used; and, (3) for various reasons (including the reasons indicated above), any actual investor may have experienced investment results during the corresponding time periods that were materially different from those portrayed for either the Moderate Benchmark or Bond Benchmark.
Current Benchmark Components
Moderate Benchmark: 28% BC Aggregate Index, 4% BC Global Agg Index ex US, 2% JPM Emer Mkt Bond +, 6% ML High Yield CP BB-B, 13.5% MSCI EAFE Index, 4.5% MSCI Emer Mkt Index, 10.5% Russell 2000, 31.5% S&P 500 Index. Bond Benchmark: 70% BC Aggregate Index, 10% BC Global Agg Index ex US, 5% JPM Emer Mkt Bond +, 15% ML High Yield CP BB-B.
Objectives and Risk
Different types of investments and/or investment strategies involve varying levels of risk, and there can be no assurance that any specific investment or investment strategy (including the investments and/or investment strategies devised or undertaken by Hewins) will be either suitable or profitable for a client’s or prospective client’s portfolio. It should not be assumed that diversification protects a portfolio from loss. No client or prospective client should assume that this Periodic Table serves as the receipt of, or a substitute for, personalized advice from Hewins or from any other investment professional. In the event that there has been a change in a client’s investment objectives or financial situation, the client is encouraged to advise Hewins immediately.
S&P 500 (Large Cap Equity)
The Standard & Poor’s 500 Stock Index (S&P 500) is an unmanaged index of 500 stocks that is generally representative of the performance of larger companies in the U.S. The index includes the stocks of 500 leading U.S. publicly traded companies from a broad range of industries.
Russell 2000 (Small Cap Equity)
The Russell 2000 Index is an unmanaged index that measures the performance of the small-cap segment of the U.S. equity universe. It is a subset of the Russell 3000 Index, representing approximately 10% of the total market capitalization of that index and includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership. Russell Investment Group owns the Russell Index data, including all applicable trademarks and copyrights.
MSCI EAFE (International Equity, Developed)
The MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization-weighted index that is designed to measure the equity market performance of developed markets, excluding the U.S. & Canada. The MSCI EAFE Index consists of the following 22 developed market country indices: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom*.
MSCI Emerging Markets (International Equity, Emerging)
The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. The MSCI Emerging Markets Index consists of the following 21 emerging market country indices: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey.
BC Aggregate (Core Fixed Income)
The Barclays Capital U.S. Aggregate Index provides a broad-based measure of the domestic investment-grade fixed income market. It is an unmanaged index of taxable, investment-grade, U.S. dollar-denominated fixed-income securities of domestic issuers having a maturity greater than one year.
BofA Merrill Lynch U.S. High Yield, BB-B Rated, Constrained (High Yield Fixed Income)
BofA Merrill Lynch U.S. High Yield, BB-B Rated, Constrained Index tracks the performance of US dollar-denominated below-investment-grade (BBB rated) corporate debt publicly issued in the US domestic market. Qualifying bonds are capitalization-weighted provided the total allocation to an individual issuer does not exceed 2%. Issuers that exceed the limit are reduced to 2% and the face value of each of their bonds is adjusted on a pro-rata basis.
BC Global Aggregate ex U.S. (International Fixed Income, Developed)
The Barclays Capital Global Aggregate Bond ex U.S. Index (unhedged) is a subset of the Barclays Capital Global Aggregate Bond Index. It is an unmanaged index considered representative of bonds of foreign countries.
JPM EMBI Global Diversified (Emerging Markets Fixed Income)
The JP Morgan EMBI Global Diversified is a uniquely weighted index that tracks total returns for U.S. dollar-denominated Brady bonds, Eurobonds, traded loans, and local market debt instruments issued by sovereign and quasi-sovereign entities. The index limits the weights of countries with larger debt stocks by only including a specified portion of these countries’ eligible current face amounts of debt outstanding.
3 Month T-Bill
3 Month Treasury Bill is a short-term debt obligation backed by the U.S. government with a maturity of 90 days.