Avoiding Timing Temptations
2014 may go down in financial history as the year that a lot of things didn’t happen to investors. For example, despite numerous nervous headlines that it might be best to prepare for the worst, there was no universal stock correction. And despite Federal announcements on tapering quantitative easing (raising short-term interest rates) in the U.S., there was no slump in the bond markets. In fact, bonds posted positive total returns in 2014 as rates fell.
Another non-event was the lack of outsized rewards for globally diversified investors. Large U.S. companies (like those represented by the Standard & Poors 500 index) happened to enjoy a remarkable, double-digit year, even as other segments of the market experienced negative to mediocre results, especially international, emerging market, and small-cap stocks.
In light of all that did not happen in 2014, you cannot allow yourself to succumb to two common behavioral biases: Recency, or giving recent events more weight than they deserve; and Tracking-Error Regret, or abandoning your personalized diversified portfolio to chase last year’s (past tense) hot returns.
In a article, “There’s a Perfect Storm Brewing,” author and columnist Larry Swedroe describes the risks associated with chasing past performance. While the U.S. S&P 500 Index has outperformed the MSCI EAFE (international stock) Index since 2010 by about 9 percent year, the MSCI EAFE happened to deliver about the same outperformance in reverse from 2002–2007. Clearly, the tables can turn abruptly and destructively for an investor who is not properly diversified. As Swedroe says, “Diversification is like insurance. It’s insurance against having all your eggs in the wrong basket.”
There are decades of resounding evidence that one year or even several years does not a strategy make. That’s why, come what may, owning an individualized globally diversified portfolio is always the right policy. Maintaining (and rebalancing) a properly diversified portfolio according to your personal goals and risk tolerances cannot guarantee that you will outperform the hottest markets or asset classes in any given year. Instead it offers the most rational approach to reaching your desired financial goals while managing the inherently unpredictable erratic returns along the way.