So far in 2017 (through December 14), almost every category of investment asset has had a very good year. Stocks, bonds, real estate and precious metals were all up. The only laggards were commodities, like oil. This year you could have picked things to invest in by throwing darts blindfolded and you would have had a good year, as long as you threw more than one. In such times it is relatively easy to make money on investments – the buy and hold stock market strategy seems like a terrific plan.
In 2017, the stars all aligned for investments with several factors playing their parts:
A growing global economy
Rising employment, without rising wages (bad for workers, but good for stocks in the short run)
Still-low but predictably and gradually rising interest rates, with no surprises from the Fed or other central banks
No major wars involving the U.S.
The prospect of corporate tax cuts in the U.S.
We need to remember though, that this is not the “normal” state of the stock market; if markets could even be said to have a normal state. Although the memory is a little fuzzy now, 2008 was not that long ago. When the stock market’s value was cut in half in that year, it then needed to double to get back to its former level. That took over five years. That simple math is what makes it so important to remember that in investing, above all, we must avoid large losses – we must consider the “risk” side of the reward/risk equation.
In any time-period there are many influences. As a quick comparison of the returns from some of the major asset classes in a few selected recent years, consider the table below. I selected the following years to show how different the landscape can be from one year to another. The years I picked were:
2008 – Crashes in real estate, stocks and oil
2011 – a zero year for the stock markets
2015 – “The year that nothing worked” according to Bloomberg – no performance anywhere
2017 – “The year that everything worked” – all asset classes except oil outperformed averages
I also added a column for 10-year average compounded total return, including price change as well as interest and dividends. The 10-year period included the crash of 2008 and the entire nine-year bull market since then (it averages in every year in that period, not just the selected years).
|Approximate Total Returns||2008||2011||2015||2017||10-yr Avg|
|Stocks – S&P 500||-36%||1%||1%||19%||11%|
|Stocks – NASDAQ 100||-42%||3%||8%||32%||15%|
|Bonds – Long-term US Treasury||31%||32%||-1%||10%||6%|
|Bonds – Other investment grade||7%||7%||2%||5%||5%|
|Diversified Real Estate stocks||-39%||5%||2%||16%||6%|
The environment we had in 2017 is a pretty rare combination, and one we should not expect to see very often. It is important to remember that the only certainty is change. Some changes will be for the better, some not, but they will happen.
The certainty of uncertainty in the stock market is why some particular principles are important in investing for your own future. These are very familiar to our Proactive Investing students, but they are worth reviewing as the new year approaches.
1. Diversification Across Asset Categories
As you can see from the table above, in any given year some things perform better than others and there is virtually no pattern to this.
All of these assets had years in which their returns were near or below zero.
The most volatile assets (stocks, oil, real estate) were capable of double-digit positive returns; but also had years where they lost 30 percent, 40 percent or even more.
Only the least-volatile assets – investment grade bonds – had positive returns in all of these years. The other side of that coin is that the long-term average return from bonds was low.
It is clearly important to allocate funds among different asset classes to avoid over-exposing ourselves to any one asset class, since almost any one of them can have a disastrous year at any time.
2. Diversification Within Asset Classes
Within a category, assets perform somewhat differently, even though all assets within the category have a strong correlation. In some years, a particular type of stock (it was tech stocks in this case, but that’s not always true) does better than the rest. In some years, treasuries do not do as well as other investment-grade bonds.
It is worth doing to allocate some funds to different members within an asset class.
3. Management of Risk for All Categories
Finally, we must manage the risk in every asset. We do not want to suffer a 30 or 40% loss on anything in any year. Each type of asset has its own risk characteristics and needs to be managed so as to allow us to participate in most of the profits while avoiding most of the losses.
We’ve discussed various aspects of these principles in past articles. They are laid out in detail in our Proactive Investing course. If your financial future is important to you, talk to your center about Proactive Investing.