INDUSTRY INSIGHT
Long-Term Investments
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In 2013, returns of 25% to 30% were not unusual, but over a longer
period of time, these returns are extraordinary. They are not the
numbers an investor should expect, or use to plan for future returns or
for long-term planning. Consider this a bonus year.
Any market cycle with exceedingly high returns, for instance the
2008-2009 market, is an anomaly. Unrealistic expectations of market
returns became common in the late ‘90s due to unprecedented returns;
PE (price/earnings) ratios were ignored, as were other fundamental
tools for valuing companies and their stock prices. While we would all
rather have extraordinarily high gains, in normal or “average” markets
these kinds of gains would require taking on additional unnecessary
risk. And along with the higher risk and the potential for higher gains is
the potential for more downside risk.
In 2013 the Dow returned 29.65%; however, for the past 70 years
(including 2013) the average annual return for the Dow has been
11.3%. Even this number is high, if looked at as a guideline. Most
individual investors have not and could not invest for a 70-year period,
and more realistically, the returns of the Dow Jones Industrial Average
for the last 20 years have averaged 9.2%.
Oftentimes we hear from clients who want to know why their
accounts did not get the same return as the Dow for the past year. If you
are well-diversified and conservatively invested then you probably do
not own “The Dow.” Your portfolio should be composed of a variety of
investments: bonds, international and domestic stocks or mutual funds,
large, mid and small cap, among others. This diversification allows parts
of your portfolio to move independent of each other. When one sector
is underperforming the expectation is that another sector is performing
better. The period from 2008-2009 was not kind to any sector, but each
investment came out of that period at different rates; diversification
helped smooth the return to normalcy. Looking at past periods of
volatility, we see distinct benefits to broad market diversification.
Bonds can be taxable or tax free or some combination of both. If you
are in a higher tax bracket, tax-free bonds investing might be a solution
to help alleviate the tax burden on other investments. Bonds don’t
typically generate returns that mirror the stock market, and should not
be expected to, but they serve a very important purpose in a portfolio.
According to the Callan Periodic Table of Investment Returns, the
S&P 500 Growth Index had returns of 42.16% in 1998; three years
later, in 2001, the same index recorded a return of -12.73, and -23.59
the following year. In contrast, the Barclays Aggregate Bond Index
had a return of 8.7% in 1998. Investors were disappointed, as stock
portfolios were doing substantially better. Many investors sold out of
bonds and added the funds to equities. Then came 2001 and while
equity indices were mostly negative, the Barclays Agg was up 8.4% and
10.3% the following year. Just as diversification seemed to be falling
out of favor, we were shown the value of keeping our investments long
term, with a conservative growth orientation and the significance of
keeping our expectations reasonable.
This Industry Insight was written by Patty John.
Patty John is an Associate Vice President, Financial Advisor
with Hefren Tillotson in the Southpointe office. Patty can be
reached at [email protected] or 412.633.1606.
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