Many mutual fund investors remaining in the stock market
are generally keeping to their time-honored belief: One must
not tinker with a strategy of sticking with a good and usually
well-known stock fund or funds, continuing to ride out any further
declines. They thereby assume that this strategy is preferable to any other
over the long haul.
Such investors have all sorts of conventional
support
on their side. After all, stocks have always come back and most conventional
advice, not to mention numerous academic experts,
continue to advocate maintaining your position through
thick and thin. Therefore, I'll call this approach a "conventional"
one. This is
certainly the majority way of investing for the countless millions holding on
to the most popular mutual funds, including the mainly large cap index
funds and many of the big managed funds offered by companies
such as Fidelity, T. Rowe Price, American Century, etc.
But no single investment approach can be thought of representing
the absolute truth. This approach, like any other reflects a set of
beliefs, that is, a bias, that may only begin to change under the
most extreme of circumstances. For example, it is
unlikely that the above bias continued to
prevail during the dark days of the Great Depression or even now characterizes
the consensus view of investors over in
Japan where stocks have been pretty much declining since 1989.
The alternatives to believing in the conventional approach
are not always easy to face: being willing to sell off at loss,
putting aside, at least temporarily, your investment goals
by going to cash, or if not, facing the exceedingly challenging
task of trying to find alternative investments that can perhaps
do better for long enough a period to justify making such switches.
I will admit that I too used to almost entirely adhere to this conventional
approach to investing. And I still continue to
manage the majority of
my portfolio largely in terms of this bias. But especially starting
in the late 90s, in response to what appeared to me to be an
unsustainable run-up in the popular, large cap, and growth style of stock funds,
I began to search for
alternate funds toward which to shift some of my portfolio.
What did I come up with? Mainly these:
"value" funds (domestic and foreign, both large and small), small and mid-cap US stock funds,
REIT (real estate) funds, and
a higher allocation to bonds in general, more recently to inflation-protected,
shorter-term, and international bonds.
As a result, I now have two strategies at work in my portfolio: some
funds managed under the same conventional bias that most people have, and others
managed under what I'll call a "divergent" bias. This latter approach may be
summarized as: "Trouble may continue brew for the foreseeable future
for the holder of
the typical US or even the typical foreign stock fund". For the last several years,
about 1/3 of my portfolio has been managed with this latter assumption
clearly in mind.
Looking back 3 to 5 years, it is now clear that, for this period at
least, it has been the divergent rather than
the conventional view that has proven to have been closer to the truth.
And frankly, I wish that even more of my portfolio
had reflected the non-mainstream approach. Let's look more closely at
how these two differing strategies have played out during this period.
Suppose one's portfolio rather closely resembled that of the
conventional approach, heavily concentrated primarily in large US
stocks and usually tilted toward a growth orientation. Given that
easily 4 times as much money was and continues to be
invested in stock funds as compared to bond funds during this period,
such a strategy at best might resemble the
following simple portfolio in terms of performance:
- 80% in Vanguard Total Stock Market Index Fund
- 20% in Vanguard Total Bond Market Index Fund
Actually, if you own only 1 or two funds, these or similar index
funds would certainly make
excellent choices. But, getting back to recent performance, if you take
the yearly returns
of these market mirroring funds and
calculate the results from the past 3 years, your total return on this seemingly
good portfolio as of
12-31-02 would have been -23.6%. That's $7,644 remaining
from an initial 10K investment.
If, on the other hand, you assembled a portfolio that reflected a combined
conventional and divergent bias, that is, including a healthy component of
the alternate kinds of funds described above, your return would
have more closely resembled a return of -5.7%, or $9,427 remaining
from an initial 10K investment. (This result is actually the one achieved
by my Model Portfolio and is broken out year by year on my
main web page.)
What were the resulting returns on the less widely held
kinds of funds one might have included in their portfolio? The following
table shows the current 3 yr. returns for each of the following
categories as compared to the annualized return of
-14.9% for the blend of mainly of large cap stocks in
the Vanguard Total Stock Market over the last 3 years thru Feb. 4, 2003:
Fund Category |
3 Yr. Return
Annualized |
|---|
Real Estate (REITs)
| +12.1%
|
International Bonds
| +7.3
|
Short-Term Government
| +7.3
|
Short-Term General
| +6.8
|
Small Cap Value
| +6.4
|
Mid Cap Value
| +2.6
|
Small Cap Blend
| -0.6
|
Large Cap Value
| -5.5 |
Since there are no major benchmarks for foreign "value" funds
or US inflation protected
funds, here are the 3 year results thru 2-4-03 for the 3 such funds I personally invested in and
recommended:
Fund |
3 Yr. Return
Annualized |
|---|
Vanguard Inflation Protected Sec.
(since inception 6-29-00) | +12.1%
|
Tweedy, Browne Global Value
| -4.3 |
Templeton Foreign A
| -5.6 |
As can be seen, funds reflecting a divergent bias outperformed a
fund closely tied to the conventional bias from anywhere between 9 and 27% per year
over the past 3 years! And even going back 5 years, the differences while
smaller, were still enough to add perhaps 3 to 5% per year to your returns, most likely
putting such a portfolio
in positive rather than negative territory over the entire 5 year period. (The current 5 year annualized
return for the Vanguard Total Stock Market Index is -2.1%.)
Thus, hindsight reveals that contrary
to the conventional bias, there are times as exemplified
over the past 5 years
when it truly paid to diverge from
the conventional approach followed by most fund investors and
frequently recommended by most fund experts!
But so much for the past. What about the
future? Although it probably would be foolhardy
to attempt to predict as far out as another five years, we are
becoming more pessimistic about continuing to stick with the
conventional bias than we were at the start of the year. As we see
it, looking ahead there appears to be little to give much confidence for stock investors
at this time. Therefore, we are lowering our suggested allocation to
stocks to 45% from 50% and raising our cash position from 0 to 5%.
As we see it, until the biggest components of most mutual funds, that is,
large cap stocks, are able to start showing a positive trend for
a sustained period,
we think that
it will continue to pay to maintain a much higher divergent approach then
you normally would consider.
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