Don’t Let Performance Haunt You Forever
By Roger Nusbaum, AdvisorShares ETF Strategist
One of the building blocks to building a diversified portfolio is the understanding that if everything in a portfolio goes up together then they are likely to all go down together when the cycle ends. Diversification means owning assets with different attributes such that the assets respond differently to various market conditions. There were after all, things that went up during the financial crisis. Whenever the next bear market comes there will be things that go up then too but I wouldn’t expect those things to go up in a raging bull market like we’ve had…or are still having?
Last week a new ETF launched that will essentially just own index puts (a whole lot of cash and cash proxies and 1% in puts) to offer portfolio protection for large market declines. The fund sponsor is quite clear that the fund will lose value in most years.
This ties together with recent comments from Mark Yusko, the CEO of Morgan Creek Capital who lays out a compellingly dour case for broad domestic indexes, the power of holding cash ala Seth Klarman and Warren Buffet and looking to invest in segments (sectors, themes, countries) where pessimism reigns and avoid where euphoria exists. He said that bull markets begin with pessimism, rally on skepticism, peak with optimism and end with euphoria.
It is a very human behavior to focus on the very short term and to think that in an uptrend, everything owned must go up as much as, if not more than, the market. Early on in the Tour de France every year you will hear one of the announcers remind the audience that the Tour cannot be won on the first (or second or third) day but it can be lost on the first day.
This idea relates here in that an investor cannot ensure financial plan success based on performance in some random year before they retire but they can lose the race in terms of doing something catastrophically stupid such that they dig a very deep hole for themselves.
A well thought out strategy focuses on longer time periods like an entire stock market cycle with goal of having enough money when it is needed. Someone who retires at 63 with enough money doesn’t say to themselves “while I am glad I have enough, those two quarters in a row that I lagged the market when I was 56 are going to haunt me forever.” As silly as that sounds, if the S&P 500 goes up 9% this year and someone is angry about only being up 6%, it is the same thing.
Over the course of an investing lifetime an average investor will have years that they outperform and years that they lag. An investor needs to accept this and an advisor needs to remind his clients of this. Financial plan success requires an adequate savings rate, suitable asset allocation, not repeating self-destructive behavior and just being relatively close to the market. Three of the four are within the control of the investor.