"Far more money has been lost by investors preparing for corrections or trying to anticipate corrections than has been lost in corrections themselves.”
This astute observation was made many years ago by Peter Lynch, the legendary Fidelity Funds mutual fund portfolio manager. Investors sometimes will maintain a high allocation of cash in a long-term investment portfolio if they believe stocks are ripe for correction. Sometimes this decision is driven by fear due to the possibility of a loss of capital. Other times it is driven by greed and the hope to enter positions at lower prices. In either case, the investor runs the risk of missing out on strong rallies in stocks. The cost of missing out on these can be next to impossible to recoup. Investors often will fail to consider the possibility that they may be wrong, and what the consequences might be if they are wrong. I believe it is a far better strategy to maintain an asset allocation within a range appropriate for the investor’s risk tolerance, liquidity needs, time horizon, etc. Subtle shifts in allocation and security selection may be beneficial, but these too must consider what the possible outcomes are.
If the preceding paragraph looks familiar to you, you have an incredible memory. It is exactly how I began my quarterly market update letter dated July 19, 2014. While the backdrop is different now than six years ago, investor’s emotions are prone to rise on occasion. It seems like every presidential cycle I witness investors being tempted to abandon their well-established investment policy and go to cash because they are unhappy with the politics in Washington. Thankfully it is rare that I witness investors act upon these emotions, but for those who have, I do not recall a single time it has worked in their favor. I believe making a dramatic change in asset allocation due to political concerns is unwise, though the political landscape can certainly drive the selection of investments. It is our job to manage your investments with a disciplined, research-driven approach, taking emotion out of the equation.
Anybody parked in cash missed out on a very strong quarter for stocks. In the third quarter, the S&P 500 index of large domestic stocks was up 8.9%, the MSCI EAFE index of established foreign economy stocks was up 4.8%, and the MSCI index of emerging market stocks was up 9.6%. Bonds held their ground with the Bloomberg Barclays U.S. Intermediate Government/Credit Index up 0.6%.
Speaking of bonds, there has been a lot of financial press about the death of the 60/40 growth and income portfolio. A portfolio comprised of 60% in stocks and 40% in high quality government bonds has long been held as being the quintessential moderate risk portfolio. While bonds broadly speaking have had an average annual return of approximately 6% over the past 70 years, it is difficult to make 6% on a 10-year Treasury Bond paying only 0.68% as of the end of September. Today’s low interest rates could therefore jeopardize a balanced portfolio’s ability to earn a reasonable rate of return above inflation.
While the income portion of a balanced growth and income portfolio has traditionally been allocated to fixed income (meaning bonds which pay a fixed rate of interest), I believe the time has come where consideration must be given to allocating a portion of this allocation to other income producing assets. Such a change is likely to increase short-term volatility in portfolios, but I believe the increased risks associated with holding bonds and the higher income that can be gained from other asset classes warrants this shift. I would be happy to discuss this with you in further detail.
I wish you a happy and healthy fall season. Do not hesitate to contact me if I might be of assistance or if you have any questions.
Sincerely,
Glenn S. Rank, CIMA®
Certified Investment Management Analyst®
President
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The S&P 500 is a broad-based unmanaged capitalization weighted index of 500 widely held large market capitalization stocks that is generally considered representative of the U.S. stock market. The S&P 600 is an unmanaged capitalization weighted index of 600 small market capitalization stocks. The MSCI EAFE index and the MSCI Emerging Markets index are unmanaged indexes compiled by Morgan Stanley Capital International that are generally considered representative of the developed international stock market and emerging international stock market, respectively. International securities involve additional risks including currency fluctuations, differing financial accounting standards, and possible political and economic volatility, and may not be suitable for all investors. Investing in emerging markets can be riskier than investing in well-established foreign markets. Investing in smaller companies can be riskier than investing in larger companies. The Bloomberg Barclays Capital U.S. Intermediate Government/Credit Bond Index measures the performance of U.S. Dollar denominated U.S. Treasuries, government-related and investment grade U.S. corporate securities that have a remaining maturity of greater than one year and less than ten years. Inclusion of these indexes is for illustrative purposes only. Keep in mind that individuals cannot invest directly in any index and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor’s results will vary.
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