Remember that the major indices don’t represent the entirety of Wall Street.
This past year we constantly heard the media reporting that the “market” is up, referring to the S&P 500. When it’s the S&P, everyone notices. They notice due to the media spotlight, and because it makes up a disproportionate percentage of many poorly diversified portfolios.
The S&P is a broad benchmark of 500 stocks. If your investments are lagging this broad benchmark, you may be asking yourself this question. “The market is up but I am not, why?” The short answer is that the S&P is not the overall market, but rather a portion of the overall market. This portion of the market is hardly indicative of “the Market.” The market includes both domestic and international stocks. It contains large cap, small cap, micro cap, value, growth, emerging markets, emerging small and emerging value stocks. Additionally, let us not forget about fixed income (short term to be prudently explicit).
A closer look at how different sections of the market did in 2014 gives us better insight, for example:
S&P 500 13.69%
Russel 1000 Value 13.45%
Russell 2000 4.89%
Russell 2000 Value 4.22%
MSCI EAFE Large Company -4.48%
MSCI EAFE Value -4.93%
MSCI EAFE Small Cap -4.63%
MSCI Emerging Markets -1.82%
Barclays Cap. U.S. Gov’t/Credit 0.26%
Keep in mind that the S&P serves as a kind of “Wall Street shorthand.” The media watches it constantly because they believe it provides a good gauge of how things are going during a trading day, week or year. Still, the S&P is not the whole stock market – just a portion of it.
You can say the same thing about the Dow Jones Industrial Average, which includes only 30 companies and isn’t even cap-weighted, like the S&P is. It makes up approximately 25% of U.S. stock market value, but it is devoted to the blue chips.2
How about the Nasdaq Composite or the Russell 2000? The same thing applies.
Yes, the Nasdaq is large (3,000+ members), and yes, it consists of insurance, industrial, transportation and financial firms as well as tech companies. It is still undeniably tech-heavy, however, and includes numerous speculative small-cap firms. So on many days, its performance may not correspond with that of the broad market.2,3
This also holds true for the Russell 2000, which is a vast index, but it’s all about small caps.
Whenever someone sees a sector of the market performing well, they naturally think that that is where they should be invested. This creates a false illusion of where one needs to be invested in order to be successful. When this happens, people often make the mistake of chasing after that hot sector. But, will it continue to do well? Nobody knows. People tend to forget that risk works both ways. Last year we saw the S&P appreciating, there is legitimate risk that this accelerated appreciating is over, and shifting anyones resources in this direction could be a big mistake. That is the risk of market timing. There are always asset categories that will perform well, but we never know which one will be the best performer and for how long. Hind site investing is always best.
For example, It is only natural that a portfolio heavily weighted in large cap stocks would outperform a diversified portfolio when large cap stocks perform well over a short period of time.
During any given year, certain segments of the market perform remarkably well and others perform poorly. Because of that ongoing reality, you must stay diversified and adopt a long-term perspective as you invest. For example, our portfolios have 19 distinct asset categories. They are designed to not be dependent on any specific asset class. This lack of dependency is designed to attempt to maximize return for a give level of risk. The goal here is to get an overall market return.
This approach is designed around risk mitigation and insulating clients from the downside risk associated with holding one (or even just a few) asset classes. The result of this more prudent strategy is that investors should not see returns that are associated with the lowest performing asset classes. On the contrary, it would be an unreasonable expectation for investors to be getting returns associated with the highest performing asset classes.
The perception of underperformance or not seeing portfolio gains can lead investors to feel the need to react and make changes to their portfolio. Unfortunately, this strategy is the wrong approach and will ultimately leave you feeling frustrated about your investments. Like I have said many times. It is not prudent to make long term investment decisions based on short term returns of one individual investment or asset class.
Citations.
1 – us.spindices.com/indices/equity/sp-500 [12/11/14]
2 – investopedia.com/articles/analyst/102501.asp [12/11/14]
3 – quotes.morningstar.com/indexquote/quote.html?t=COMP [12/11/14]
4 – web.wilshire.com/Indexes/Broad/Wilshire5000/Characteristics.html [12/11/14]
5 – money.cnn.com/quote/quote.html?symb=W5000FLT [12/11/14]
This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. The NASDAQ Composite Index is an unmanaged, market-weighted index of all over-the-counter common stocks traded on the National Association of Securities Dealers Automated Quotation System. The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is not possible to invest directly in an index. NYSE Group, Inc. (NYSE:NYX) operates two securities exchanges: the New York Stock Exchange (the “NYSE”) and NYSE Arca (formerly known as the Archipelago Exchange, or ArcaEx®, and the Pacific Exchange). NYSE Group is a leading provider of securities listing, trading and market data products and services. The New York Mercantile Exchange, Inc. (NYMEX) is the world’s largest physical commodity futures exchange and the preeminent trading forum for energy and precious metals, with trading conducted through two divisions – the NYMEX Division, home to the energy, platinum, and palladium markets, and the COMEX Division, on which all other metals trade. Additional risks are associated with international investing, such as currency fluctuations, political and economic instability and differences in accounting standards. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This material was prepared by MarketingLibrary.Net Inc., for Mark Lund, The 401k Advisor, Investor Coach and author of The Effective Investor. Mark offers investment advisory services through Stonecreek Wealth Advisors, Inc. an independent, fee-only, Registered Investment Advisor firm providing 401k consulting for small businesses and financial Advisor services for professional athletes and individuals. Stonecreek is located in Salt Lake City, Murray, West Jordan, Sandy, Draper, South Jordan, Provo, Orem, Lehi, Highland, Alpine, American Fork all in Utah.