The S&P 500 index has become the de facto barometer for the overall health of global financial markets. Individual investors are accustomed to using this index as a benchmark to gauge just how well their portfolios have performed each year.
What makes matters worse is that the S&P 500 surged over 13% last year, and many well-diversified investors are frustrated to see their portfolios return a mere fraction of the index’s performance in 2014.
This emotional response is completely understandable given the fact that the media has chosen this index to reign supreme. Turn on the TV and investors see nothing but the S&P 500 with commentary by market pundits on their views on the future direction of these indices.
However, the S&P 500 only tracks a very specific type of equity in a single geography – large cap stocks in the U.S. The index is nowhere close to being a representative benchmark for the global financial market, and investors are strongly urged to keep this reality in mind the next time you compare your overall portfolio performance relative to the S&P 500.
Diversification is the “Golden Rule” of investing, and investors are to maintain broad-based diversification at all times. There is simply no exception to this rule, and those who choose to ignore are playing with fire.NOTE: I’m guessing that most investors know a friend, family member, or other acquaintance who had every intention to retire around 2008 but postponed due to being over-indexed to equities during the financial crisis.
The concept of diversification goes much deeper than simply owning a large portfolio of stocks across various sectors. Investors must consider other geographies and asset classes and then monitor how the relationships between these assets change over time.
Let’s take a look at the performance of various asset classes over the last two years to see why it was so difficult for well-diversified investors to beat the S&P 500.
Financial Market Index 2014 Total Return 2013 Total Return
U.S. Large Cap Stocks S&P 500 13.7% 32.4%
U.S. Small Cap Stocks Russell 2000 4.9% 38.7%
U.S. Aggregate Bond Barclays AGG 5.9% -2.1%
Global Developed Markets MSCI EAFE -4.9% 22.8%
Emerging Markets MSCI EEM -2.2% -3.7%
Oil WTI -45.9% 7.2%
This information highlights two very important conclusions for investors:
1. Too Many Eggs: Asset class returns in aggregate were not that great in 2014. The only way an investor could have achieved returns anywhere close to the S&P 500 was to put all his/her eggs in one basket. Doing so would have broken nearly every rule regarding diversification and exposed a tremendous amount of risk and volatility to a portfolio.
2. Last Year Was Tough: The difficulties in 2014 are more apparent when compared to global returns in 2013. That year, the S&P gained a whopping 32.4%, developed international stocks gained 22.8%, and both mid and small-cap U.S. indices far outpaced the S&P. Meaning, a diversified portfolio in 2013 performed far better versus 2014 because it was fueled by more than just the S&P 500.
In fact, investors should have expected even lower returns in 2014 from a well-diversified conservative portfolio. Based on Morningstar’s conservative allocation across five main target risk indices, their portfolio only returned 3.38% last year (falling 0.73% in the second half of the year as oil began to plunge).
The bottom line is that delivering returns anywhere close to the S&P 500 last year would have been nearly impossible in a well-diversified portfolio. Furthermore, those who did see returns in line with this index should be furious with their financial advisor and demand to know why there was so much risk and volatility in the portfolio.
The Standard and Poor’s 500 is an unmanaged, capitalization weighted benchmark that tracks broad-based changes in the U.S. stock market. This index of 500 common stocks is comprised of 400 industrial, 20 transportation, 40 utility, and 40 financial companies representing major U.S. industry sectors. The index is calculated on a total return basis with dividends reinvested and is not available for direct investment.
This commentary is not intended as investment advice or an investment recommendation. It is solely the opinion of our investment managers at the time of writing. Nothing in the commentary should be construed as a solicitation to buy or sell securities. Past performance is no indication of future performance. Liquid securities, such as those held within DIAS portfolios, can fall in value. Global Financial Private Capital is an SEC Registered Investment Adviser.
We are an independent financial service firm helping individuals create retirement strategies using a variety of investment and insurance products to custom suit their needs and objectives. Financial planning, investment advice and insurance provided through Business-owner Strategies Group, LLC a North Carolina Registered Investment Adviser and Licensed Insurance Agency d/b/a BSG Advisers. Wealth CAPS does not provide legal or tax services.