I had the pleasure of attending Vanguard’s Investment Symposium here in Chicago recently. The entire session was excellent and very well done. The highlight for me was the opportunity to hear Gus Sauter, Vanguard’s recently retired Chief Investment Officer, speak. Gus closed his presentation with several investing lessons that I want to share with you.
Equity volatility is a fact of life
We experienced two sharp, drastic stock market downturns in the first decade of this century: 2000-2002 and 2008-2009. In addition we had the Flash Crash in 2010 and a sharp downturn in 2011 following the fiscal wrangling in Washington. Whether event driven or driven by other factors; volatility in the stock market is a fact of investing life. I suggest that you embrace this volatility or at least factor it into your financial planning assumptions.
Sauter’s suggestion: Ignore emotional reactions to market volatility and stay the course.
Despite lower expected returns, bonds still play a significant role
Coming out of 2008 many very solid bond funds suffered large losses that were based almost entirely on investor’s fears of anything that wasn’t a Treasury. I was able to earn some very solid returns for my clients post-2008 via the use of selected bond funds. The poor performance of bond funds YTD in 2013 is likely a preview of the low upside many of see in bond funds going forward, especially when the predictions of higher interest rates actually comes to fruition.
According to Mr. Sauter bonds still have a role in most portfolios as a diversifying element. Bonds have historically done well when stocks haven’t. Going forward bonds will likely revert to their more traditional role of reducing investment volatility.
Sauter’s suggestion: Maintain a balanced portfolio.
Manager selection is difficult, past performance is not a predictor of future returns
Selecting an active mutual fund manager who is likely to outperform their benchmark on a consistent basis is difficult. Sauter presented a slide that showed that mutual funds underperformed their benchmark by an average of 120 basis points in the 36 months following their receiving a 5 star rating from Morningstar. This isn’t a knock on Morningstar as they would be the first to admit that their star system is not a predictive ranking but rather one that rewards funds based upon past performance.
Sauter’s suggestion: Focus on low cost investing.
Market timing is difficult
Sauter cited a USA today graph that showed that over a six month period ending in June of this year buy and hold investors achieved returns that were almost 75% higher than a group of investors with a portfolio turnover rate ranging from 51% – 75% during the same period. This during a period of strong stock market returns.
Sauter’s suggestion: Establish a strategic asset allocation and think long-term.
Investing fads come and go. A long-term investing strategy that is tied to a sound financial plan is timeless.
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