Our condolences to those who have suffered the loss of family or friends as a result of the tragic events of the past week.
Our Newsletter continues to believe in the long-term prospects of mutual fund investing and will continue to do so no matter how bad the current or future climate gets.
We hope that you are among those relatively lucky investors who saw the wisdom of diversification, especially during the last few years. I say "relatively lucky" because even being diversified does not mean you haven't most likely suffered losses during this period. But the losses (just on paper, or otherwise) for those with stock-only portfolios have been in most cases been just awful.
Just several weeks ago, I received e-mail from a reader stating the following:
"I have ... started reading your current and past newsletters, and other items too. They all suggest various asset allocations, like 60/40, etc."
He goes on to state that since for last 25 years, the S&P 500, as represented by the Vanguard 500 Index, has beaten all other categories of funds, so since we all have limited money "why not put all of it in the S&P 500 instead of splitting it up between a number of funds that never ...even came close to beating the S&P 500?"
The following was my answer back then:
"The 500 Index fund has indeed done very well since its inception in 1976. But stock market history goes way back before 1976! And I believe that if you look at the extremely long-term record, going back more like 50 and 75 years, other categories of funds aside from the large-cap stocks in the S&P 500 have been even better performers. These categories include both small cap stocks and value stocks which have very long-term performance records that exceed those of large-cap stocks by about 1%. So all the fund performances you cite may have been true during relatively recent periods, but not necessarily always or in the future."
"Although I dont have any great issue with someone who decides to hold just Vang. Idx 500, you would be putting all your eggs in one basket. Studies show that certain combinations of fund categories into a single portfolio greatly reduce your portfolio's volatility and risk level. And by adding fund categories such as the above, and also international funds, you may even achieve a better return. But again these studies are longer term than the data you cite."
"The 60/40 asset allocations obviously are for people who wish to include bonds in their portfolio. Although you may come out ahead if you hold 100% stocks and dont touch them for years and years, many people do in fact wind up cashing out funds after shorter periods. If you have 100% stocks and need to cash out, you run the risk of cashing out when stocks arent doing that well. In this case, you probably wont achieve the great returns that show up in the performance tables. Bonds are also helpful if you are depending on your investments to provide a source of current income; if not, then you might elect to dispense with them."
"I dont think there is a definitive single answer to your question since a lot of it depends on what your goals are, how much time and effort you have to spend on your investments, etc."
The events of this month prove even more clearly that none of us can foresee, and certainly not control, the external factors that affect the value of our investments.
Early on, we realized that there was a potential conflict between publishing our Newsletter and also espousing the long-term philosophy of investing that we hold. After all, if investing primarily consists of choosing high quality investments and holding on for the long-term, what is there to say once or even twice a month in a newsletter?
We have taken the view that since external events are not within the power of investors to foresee, that the main purpose of our newsletter is to describe to you things that are within your power to control. These are the decisions you make often in response to external circumstances, such as the tragedy that we are all now trying to cope with.
Among the decisions that you do have control over is how you choose to react to the tragedy in terms of your investing. Will you sell out of stocks? Will you re-double your efforts at diversification? Or will you basically do nothing?
Like others, we believe that selling your stocks at this point will prove to be a long-term mistake although we have no illusions that the overall stock market will recover quickly. But we still do think it makes sense to make sure you have your assets well diversified which may require that you go gradually from some over-represented categories in your portfolio to ones that are under-represented. We have discussed which categories of funds you might consider in several recent issues and this hasnt changed much in that regard.
If your portfolio was already well diversified, then doing nothing may indeed be a good choice. If, for example, your portfolio was about 60/40 a (stocks/bonds) about a month or two ago, then as a result of the losses in stocks and the gain in bonds, your allocation has now changed to perhaps about 50/50 right now without doing anything.
Tom Madell, PhD
