Portfolio performance matters, but not the way you’d expect from watching the cable news shows.
When bad news comes out, new investors want to sell right at the top and watch the market fall in an orderly fashion. As uncertainty subsides, they plan to buy just before the market starts going back up.
Financial markets don’t work that way, and 2020 is a great example. Many asset classes declined quickly in the face of panic selling, but then quickly shot back up “too early,” before the panickers convinced themselves to buy back in. These investors had to choose between buying back in at new highs or waiting for another pullback, neither of which is very palatable. If that pullback comes, it will seem like a scary time to buy back in, and the unpleasantness will continue.
Even for investors who hold on during challenging markets, it’s easy to be lured away from a balanced portfolio by the siren song of headline numbers. For example, the S&P 500 is a large-cap stock index that has come to represent the overall “market” to most investors. In years that large-cap domestic stocks outperform other asset classes, investors wonder, “Why don’t I just buy the S&P and forget about it?”
That plan works in years where the single asset class is the best performing horse in the race, but such a portfolio is in grave jeopardy when this single asset significantly underperforms other balanced assets. The performance of a single stock like Tesla or Netflix might sing an even louder siren song than a single index, but the perils of a concentrated position in a single stock far outweigh the risk of even an all-stock index like the S&P 500.
What is the risk to you? As retirement approaches, the sequence of returns starts to matter as much as the actual performance experienced, if not more. Imagine a single investment that has an excellent annualized return for a five- or 10-year period, but shows poor returns early in the period and high returns towards the end. If you switch from accumulating your portfolio to spending it early in this period, you’ll be selling an unduly large portion of your portfolio at low prices to meet basic needs. Taking consistent dollar withdrawals over time, an investor will be selling too many shares at low prices early in the period. Even when the price recovers, such an investor won’t have enough shares left to meet their goals.
That sort of scenario is exactly why the Telarray Observatory process exists. We have shown time and time again that substituting a single asset such as an S&P 500 index fund for the recommended diversified portfolio significantly increases instances of portfolio failure in our model. This is true even when the long-term average returns of the single asset are higher than the returns of the diversified portfolio.
We all have one portfolio and one lifetime to live. Chasing some extra return might pay off, but one significant drawdown (due to a “once in a lifetime” event that sure seems to come around more than once in a lifetime) can be devastating to your way of life and your family’s future. There are no guarantees, but a well-diversified portfolio greatly reduces this risk.
Performance matters, but what really matters is to make sure a portfolio will outlive its owner. This drives everything we do at Telarray, from our Observatory process to our Advisors’ rigorous financial planning to the work of our investment committee and trading team. Our primary tool to achieve this goal is a well-constructed, diversified portfolio. That portfolio may not put up the headline numbers of the current hottest index or stock, but over time, we believe it is the best path to a secure financial future.