Objective information about retirement, financial planning and investments


Investing: Time and Diversification are your Friends


Each quarter Dr. David Kelly and his staff at JP Morgan Asset Management publish their Guide to the Markets.  This is a comprehensive chart book of investment and economic data that I find invaluable.

For the past several quarters the Guide has included this chart which as a long-term investor should be quite important to you.

The chart depicts the range of average annual returns for stocks, bonds, and a combination of the two over rolling 1, 5, 10, and 20 year periods from 1950 through 2013.  In my opinion every investor should understand the impact of diversification and time on their investments as depicted on the chart.

Understanding the chart 

The green bar depicts stocks, the light blue bar depicts bonds, and the grey bar depicts a 50-50 mix of the two.

As you can see the greatest volatility of return occurs over rolling 12 month periods.  The range of a 51% gain to a 37% loss in a 12 month period is huge.  The range for bonds is more compact and the range for a 50-50 mx of stock and bonds is slightly more compact.

As you move out to the 5, 10, and 20 year ranges you will note that the ranges from the largest gains to smallest (or a loss) become smaller with the passage of time.

Also of note is that in no 5, 10, or 20 year rolling time frame depicted does a 50-50 mix of stocks and bonds result in a negative return over the holding period.

What does this mean to you as an investor?

Diversification dampens the variability of your returns. As you can see from the chart stocks have a wider range of returns over all of the periods depicted than do bonds.  Combining the two tends to dampen the volatility of your portfolio.  Further enhancing the benefits of diversification is the fact that stocks and bonds are not highly correlated.

Taking this a step further, while an investment in an index mutual fund like the Vanguard 500 Index (VFINX) would have lost money if held over that 10 year period 2000-2009, a portfolio that was diversified to include fixed income, small and mid-cap funds, international equities, and other asset classes would have recorded gains during that same time period.

Time reduces the volatility of returns. I will leave any scientific explanation to those more attuned to this than myself, but certainly part of the reason are the ebbs and flows of market and business cycle factors that have an impact on stocks and bonds.  These might be recessions, interest rate movements, or other factors.

Implications for the future

The performance and characteristics of stocks and bonds might well differ in the future.  Diversification for most investors will likely mean holding more than just Large Cap domestic stocks and Intermediate Bonds as the graph depicts.  A few thoughts for the future, especially in this market environment of record highs for many stock market indexes:

  • Diversification reduces risk.
  • Diversification among assets with low correlations to one another further reduces risk.
  • Diversification is important because we have no way of knowing which investments or asset classes will perform well or poorly or when.
  • A longer holding period will generally serve you well as an investor in terms of smoothing out portfolio volatility. 

While every investor is different as is every investment environment, diversification and patience can be two of your greatest allies.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email.

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5 Investing Lessons Learned So Far in 2013

English: Markowitz-Portfolio Theory, Investmen...

The first half of 2013 is in the books.  It’s been a good year in terms of the domestic stock market; other areas of the markets have been mixed.  The second quarter saw declines in most fixed income categories, real estate, and in many international stock categories including emerging markets.  Commodities and precious metals have also suffered setbacks of late.  As an investor this is a good time to take stock of your investments and more importantly any implications for your financial planning goals.

When reviewing your portfolio keep these 5 investing lessons learned (and relearned) in the first half of 2013 in mind.

Components of a diversified portfolio can lose money 

Diversification and balance are generally good characteristics for an investment portfolio.  However it is not uncommon for some components of a well-balanced portfolio to lose money over a quarter or longer.  Case in point during the second quarter of 2013 virtually all fixed income categories lost money.  Of the major bond investment styles high yield led the way with a loss of 1.4% for the quarter while TIPs suffered the worst loss at 7.0%.  The fact that some components of a diversified portfolio might suffer a loss at various times should not come as a surprise as one of the goals of diversification is to include some asset classes with a low correlation to other portfolio holdings.

Gold doesn’t always glitter 

Gold, touted by many as the ultimate safe haven investment really took it on the chin during the second quarter.  The main Gold ETF (ticker GLD) lost 22.89% in the second quarter and is down 26.48% for the first six months of 2013.  This brings the five year trailing return of the ETF down to 5.44% compared to 6.92% for the S&P 500 ETF (ticker SPY).  Gold may ultimately stage a major comeback but these results fly in the face of the doom and gloom folks who tout Gold and other hard assets as the ultimate investment solution.  A college economics professor once told the class that investors in Gold had not progressed past Freud’s anal stage of development.  That may or may not be true but like anything else a portfolio that is top-heavy in Gold and precious metals may not be the answer.

The stock market can go up even if Apple doesn’t 

Apple, the largest component of the S&P 500 index, lost 24.42% over the first six months of 2013.  However the index still gained 13.82% over the same period of time.  Apple is also a large holding for many large cap mutual funds and ETFs.

The rally in bonds may be over, or maybe it isn’t 

As I mentioned above, the second quarter was dismal for bonds of all types.  Bonds and bond mutual funds have enjoyed 30 years of mostly continuous gains, in large part due to a favorable interest rate environment.  Some say the favorable period for bonds may be over, but others say investors who have yanked $ billions from bond funds may be overreacting.  Time will tell.  One thing is certain to me is that this is a good time to evaluate your fixed income investments and to look at the duration risk that you are taking.

Investors are enthusiastic when things “feel good” in the markets 

As typified by an infuriating commercial for John Hancock showing several couples saying they need to get back into the markets now, more investors have been finally feeling good about getting back into the markets after the market drop of 2008-09.  It’s easy to invest when things feel good; it’s profitable to invest when they don’t.  If you are an investor just getting back into stocks now you need both a good financial plan and a financial advisor who knows what he or she is doing.

Six months into any year is a good point to review your investments and your progress against your financial plan.  Given the wide variations in performance among various asset classes this is an especially good point to review your situation.

Please feel free to contact me with your investing and financial planning questions.  Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services.  

For you do-it-yourselfers, check out Morningstar.com to analyze your investments and to get a free trial for their premium services.  Please check out our Resources page for links to some additional tools and services that might be beneficial to you.

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Investment Diversification – A Look at the Basics


Investment Diversification is one of the basic tools  of building a sound investment portfolio. Diversification is the fancy name for  the advice your mother might have given you:  Don’t put all of your eggs in one basket. This is the basic tenant behind asset allocation, a key diversification tool.

Market Jitters...

My fellow finance blogger Ken Faulkenberry defines investment diversification as follows:

“Investment portfolio diversification is a portfolio strategy combining a variety of assets to reduce the overall risk of an investment portfolio. “  

A basic look at diversification 

Based on Ken’s definition you could use stocks, bonds, mutual funds, ETFs, private equity and a whole host of assets and asset types in building a diversified portfolio.  In the examples that will follow I am going to limit this to mutual funds investing in stocks and bonds.  Please note that nothing that follows should be construed as advice or a recommendation of any kind.  The mutual funds and allocation percentages used are for example only. 

Let’s start with an investor with $100,000 to invest.  Let’s go back in time to January 1, 2000.  One thought would be to pick a fund that invests in a variety of stocks.  Perhaps the Vanguard 500 Index Fund (VFINX) is a good choice.  How much would an investment of $100,000 have grown to by December 31, 2009, the end of the press has deemed the lost decade?  The answer is that your $100,000 investment would have shrunk to $90,165 for an average annual loss of 1.03%.  Truly a lost decade for this investor.

Let’s say this investor added the following funds to his portfolio:

  • Vanguard Small Cap Index (NAESX)
  • Vanguard Mid Cap Index (VIMSX)
  • Vanguard Total International Stock Index (VGTSX)

How much would an investment of $100,000 invested equally in each of these four funds have grown to by December 31, 2009?  (We are assuming no taxes or rebalancing in this and all examples in this article)  The answer is $137,511.  This is $47,346 or about 52% more than an investment of our investor’s cash only in the Vanguard 500 Index.  Let’s look at the average annual investment returns for each of these funds for the period 1/1/2000 – 12/31/2009:

Vanguard 500 Index -1.03%
Vanguard Small Cap Index  4.36%
Vanguard Mid Cap Index  6.13%
Vanguard Total International Stock Index 2.29%


While the average annualized return of 3.23% over the course of the decade is nothing to write home about, it does illustrate the potential benefits of diversification.

Let’s add some bonds 

Some say building a portfolio is much like cooking, which is one of my favorite pastimes.  My motto in the kitchen is “… when in doubt add more wine…”  Sadly wine and investing are not a good mix.

What if we added some bond funds to the mix?  In this case let’s add the following funds:

  • PIMco Total Return (PTTRX)
  • T. Rowe Price Short-Term Bond (PRWBX)
  • American Century Inflation Adjusted Bond (ACITX)
  • Templeton Global Bond (TPINX)

If we now divide the investor’s $100,000 investment equally among the four equity funds from the prior example and among these four bond funds, by 12/31/2009 the $100,000 investment has grown to $174,506 or almost double what an investment of $100,000 in the Vanguard 500 Index Fund alone would have yielded.  The portfolio’s average annual return was 5.72% for the decade.

Looking at the average annual investment returns for each of the bond funds for the period 1/1/2000 – 12/31/2009:

PIMco Total Return 7.65%
T. Rowe Price Short-Term Bond 4.89%
American Century Inflation Adjusted Bond  7.20%
Templeton Global Bond 10.66


The impact of diversification

Again this example was based on eight funds weighted equally with no rebalancing and the reinvestment of all distributions.  This was an unusual decade in that bonds largely held their own or outperformed equities.  It is likely that if we performed this same analysis for the ten years ended December 31, 2019 the results would look different.  None the less there are a few things we can take away from this analysis:

  • The decade 2000-2009 was a poor one for large cap stocks as illustrated by the use of the S&P 500 index fund.
  • Small, mid cap, and international equities outperformed domestic large cap stocks.
  • Diversifying the equity holdings in this example boosted overall portfolio return.
  • Bonds were aided by generally declining interest rates and lower volatility than equities.  Both of these factors helped their overall return for the decade and really boosted our hypothetical portfolio.  Bonds in general have a relatively low correlation to equities which assisted in mitigating the volatility of our portfolio and enhanced returns.
  • Even in this “lost decade” asset allocation helped enhance return.

What does this mean for the future? 

Clearly the period used in the analysis was unique one, a decade that contained market declines (as measured by the S&P 500 Index) of 49% from March of 2000 through October of 2002 and 57% from October of 2007 through early March of 2009.  However it seems that market volatility has become the norm rather than the exception so the current decade will likely be an interesting one as well.  A few lessons we can take forward:

  • Diversification reduces risk.
  • Diversification among assets with low correlations to one another further reduces risk.
  • Diversification is important because we have no way of knowing which investments or asset classes will perform well or poorly or when.


Note that all data used in this article was generated via Morningstar’s Advisor Workstation.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner.

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Asset Allocation Basics

Difference Between Stocks and Bonds

The theory behind diversification, or asset allocation, is to spread your investments across different asset classes to help protect your portfolio from downturns in any one asset. Diversification is a defensive strategy – it is meant to protect your portfolio during market downturns and to reduce your portfolio’s volatility.

Your asset allocation strategy will depend on your risk tolerance, return needs, and time horizon for investing. While each person’s asset allocation strategy will be unique, you should consider these tips:

To moderate your portfolio’s risk, invest in both stocks and bonds. Stocks tend to have a low positive correlation with corporate and government bonds, meaning that on average, movements in stock prices will only moderately match movements in bond prices. Thus, owning both reduces your portfolio’s risk.

With a long time horizon, you can increase your allocation to stocks. By staying in the market through different market cycles, you reduce the risk that volatility will adversely affect your equity performance. Those with a time horizon of less than five years should not be invested in stocks. Look at cash and bonds for those short-term needs.

Diversify within as well as among investment classes. For instance, in the stock category, consider value and growth stocks, small- and large-capitalization stocks, and international stocks. Bonds could include long-term bonds, intermediate-term bonds, high-quality bonds, lower-quality bonds, Treasury securities, municipal bonds, and international bonds.

Make sure you have reasonable return expectations for various investment categories. Basing your investment program on return estimates that are too high could cause you to increase the risk in your portfolio in an attempt to obtain higher returns.

Once you develop an asset allocation strategy, rebalance it at least annually. Since your strategy is designed to provide a stable risk exposure, you need to periodically rebalance so your allocation does not get out of line.

Make sure you have enough cash to handle short-term needs. That way, you won’t have to sell investments at an inappropriate time, such as immediately following a market downturn.

Evaluate new investments carefully, ensuring they add diversification benefits to your portfolio.

Don’t keep adding similar investments, such as several stocks in the same industry. Not only does this not add much in the way of diversification, but it makes your portfolio more difficult to monitor.

Avoid following the market too closely. Your asset allocation strategy is designed to guide your portfolio’s long-term makeup. Don’t rethink that strategy simply as a result of a market downturn.

Please feel free to contact me with your financial planning and investing questions.

Please check out our Resources page for links to some tools and services that might be beneficial to you.

Photo credit Flickr

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