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I offer my opinion on a tiny account for a distant cousin. It consists of a single balanced mutual fund. Since it’s a balanced fund of index funds, there haven’t been any performance surprises over the years. Or so I thought until last week, when I saw that the fund’s return through the end of the 3rd quarter this year was just 2.7%. With the U.S. stock market up more than 10% through September 30, how could the balanced fund’s return be that low, I wondered? Did someone make a mistake? Then I did what I seldom do, and I looked at the return of my own portfolio so far this year. More tilted to bonds than the balanced fund, I discovered that my own beautifully diversified portfolio (if I may say so) had returned yet less.

The 3rd quarter data has crystallized for many investors –and not just my cousin- that this has been an uncommonly difficult year to own a diversified portfolio of stocks and bonds. How difficult? In tracking the performance differential between the U.S. stock market and diversified portfolios since the beginning of 2000, we will see that this year –so far- has evidenced the most disappointing performance this century.


A Simple, Balanced Portfolio

While each investor has unique decisions to make, the balanced investor in textbooks starts with an allocation of 60% stocks and 40% bonds, a not-too-hot, not-too-cold, Goldilocks-pleasing allocation. Of what does that portfolio consist? For the bonds, the major benchmark is the Aggregate Bond Index. For U.S. stocks, the major benchmark is the S&P 500. For foreign stocks, the most closely followed index is the EAFE, which stands for Europe, Australasia and Far East. How do we think about the split between the U.S. and foreign markets? Many institutional investors maintain that since roughly half of the world’s stock market capitalization is based in the U.S., portfolios of publicly traded stocks should also be roughly half in the U.S. and half overseas. However, most U.S.-based investors understandably prefer to emphasize local returns. So let’s imagine that a simple, balanced portfolio has an allocation of 40% bonds, 40% U.S. stocks, and 20% foreign stocks.

Returns and Risks, Measured

Going back to 2000, and measuring 2018’s results through September 30, we find that such a balanced portfolio generated an annualized rate of return of 5.4% (excluding advisory fees and any other expenses) per year. That may seem awfully low for almost two decades of investing, but remember that as bad as the financial crisis of 2007-2009 was, global markets pretty much fell in half in 2000-2002 as well, so this 18.75 years of data includes 2 huge downturns.

A bit better than the globally balanced portfolio of stocks and bonds, the S&P 500 earned an annualized rate of return of 5.7% over this same time period. The incremental return came with incremental volatility, of course. During 2000-2002, for example, the S&P 500 fell almost 40% while the balanced portfolio fell by only 15%. Over the whole period, the standard deviation (a measure of the degree of fluctuation) of the S&P 500 was 70% higher than that of the balanced portfolio. You can see why the textbook likes the balanced portfolio: balanced investors often get a larger part of the return of the stock market while experiencing a smaller part of the risk.

Two Ways to Disappoint

If the data say the balanced approach was the way to go the past couple of decades, that wasn’t the case with any kind of consistency or predictability. During what years did the balanced portfolio perform worse relative to a portfolio consisting of just U.S. stocks? That depends upon what your definition of “relative” is, but a couple of obvious choices come to mind. We can compare the balanced portfolio and an all S&P 500 portfolio on a simple X minus Y basis and see when X was larger than Y by the widest margin, or we can derive a quotient of the portfolios, X divided by Y, and see when the relative return of the balanced portfolio was the lowest. The Monday Morning Quarterback within each of us makes both calculations, and then anchors on whichever is more painful.

If we start with X minus Y, and as you can see on the accompanying Exhibit, the worst year for the balanced portfolio was 2013, with a return almost 16% below that of the S&P 500. No other year saw a differential as large as 8%, although in 2003 the balanced portfolio was almost 8% lower than that of the S&P, and so far this year the differential has been more than 7%. These are the toughest 3 years. Having said that, 2013’s “disappointing” balanced portfolio return was still almost 17%, and in 2003 the balanced portfolio return was almost 21%. These very high returns were not far removed from massive market declines, and surely no balanced investor felt anything but joy. In this light we can see that this year’s roughly 3% return –more than 7% below the all U.S. stock portfolio and following not a big decline but rather 9 consecutive years of positive returns for U.S. stocks- invites regret in a way true of no other year so far this century.

If we instead measure X divided by Y, and eliminate the 6 years since 2000 in which the balanced portfolio earned a higher return than the S&P 500, we find that, on average, the balanced portfolio return was 64% that of the all stocks portfolio. What year was the quotient of the balanced portfolio the worst? By this metric, too, this year’s balanced portfolio return is the most disappointing, just 31% that of the S&P 500. So no matter your methodology of regret, this has been a tough year to own a balanced portfolio.

Woulda Coulda Shouda

The investment lesson of the 1980s was “just buy Japanese stocks.” The lesson of the 1990s was “just buy tech stocks.” The lesson of the 2000s was “just buy bonds.” And the lesson of the past 10 years has been “just buy U.S. stocks.” We know these things as confidently as we know the outcome of yesterday’s sporting contests. Yet there is an important difference. In sports, the team that wins and wins is likely to continue winning. This is because virtually every contest starts with a tie score, and the team we all know is stronger (the Warriors come to mind) is very likely to beat the weaker team. But that’s not how investing works. When we buy stocks and bonds today, the price we pay for “winning” securities (recently, U.S. stocks) is different than the price we pay for “losing” securities (recently, for example, foreign stocks, or bonds.) Such price differentials often grow wider than many can imagine, but over the long term it’s a mean reverting investment world. And there is always a point at which previously successful owners of Japanese stocks, tech stocks, bonds, or even U.S. stocks may discover that they have allocated too much of their portfolios to expensive securities. Selling high and buying low sounds like a good idea, but it wars with our gut.

We see this year that diversification works even when we don’t want it to, and we can safely predict that balanced investors will continue to experience months and years of disappointing returns. But while we are at risk of deluding ourselves into thinking we knew what happened was going to happen (“yeah, I knew Trump was going to win, and then the market was going to tank, I mean, uh, rally …”) no one can time the market. And so just as we can’t know when the disappointing periods will occur, we can’t know which years we’ll pat ourselves on the back for a job well done. Time is on the side of diversification, however. In an always uncertain investment environment, the most reliable way to preserve and grow wealth is to maintain a consistent and balanced approach across multiple markets of stocks and bonds. Even if it frequently seems otherwise.

Diversification Helps Long-Term, But Not Necessarily Year-to-Year

Exhibit: Major Index Rates of Return1 – January 1, 2000 to September 30, 2018


S&P 500 Index2 (X)


Barclays US Aggregate Bond Index4

Balanced Portfolio (Y)5

S&P 500 Index vs Balanced Portfolio

Time PeriodRate of ReturnTime PeriodRate of ReturnTime PeriodRate of ReturnTime PeriodRate of Return = X-Y = X/Y
Annualized Rate of Return5.7%Rate of Return3.2%Rate of Return4.8%Rate of Return5.4%

Source: Bloomberg for the annualized returns for the S&P 500 Index, MSCI EAFE Index and Barclays US Aggregate Bond Index

1. The rates or return shown are those of indices that cannot be invested in directly. The results assume the reinvestment of all dividends and interest.

2. The S&P 500 Index is the Standard & Poor’s composite index of 500 stocks, a widely recognized, unmanaged index of common stock prices.

3. The MSCI EAFE or Morgan Stanley Capital International EAFE Index is a market capitalization weighted index composed of companies representative of the market structure of 21 Developed Market countries in Europe, Australasia and the Far East.

4. The Bloomberg Barclays US Aggregate Bond Index, which until August 24, 2016 was called the Barclays Capital Aggregate Bond Index, and which until November 3, 2008 was called the Lehman Aggregate Bond Index is a broad base index often used to represent investment grade bonds being traded in the United States.

5. The Balanced Portfolio consists of 40% S&P 500 Index, 20% MSCI EAFE Index and 40% Barclays US Aggregate Bond Index. The rates of return do not reflect the deduction of advisory fees and any other expenses an investor would have paid. The results assume the reinvestment of dividends and interest. The portfolio was rebalanced to the original allocation percentage at the end of each calendar year. This Balance Portfolio is not representative of any B|O|S portfolio model recommended to clients.

6. For illustrative purposes, eliminated the results because the Balanced Portfolio earned a higher return than the S&P 500 Index.

The information presented within is for informational purposes only and is not intended to be used as a general guide to investing or financial planning, or as a source of any specific recommendations, and makes no implied or expressed recommendations concerning the manner in which any individual’s account should or would be handled, as appropriate investment or financial planning strategies depend upon the individual’s specific objectives. It is the responsibility of any person or persons in possession of this material to inform himself or herself of and to seek appropriate advice regarding, any investment or financial planning decisions, legal requirements, and taxation regulations which might be relevant to the topic of the information presented within or the subscription, purchase, holding, exchange, redemption or disposal of any investments.

The information presented within does not constitute a solicitation in any jurisdiction in which such a solicitation is unlawful or to any person to whom it is unlawful. Moreover, the information presented within neither constitutes an offer to enter into an investment agreement nor an invitation to respond by making an offer to enter into an investment agreement.

Opinions expressed are current opinions as of the date appearing in this material only and are subject to change.  No part of this material may, without the prior written consent of Bingham, Osborn & Scarborough, LLC, be (i) copied, photocopied or duplicated in any form, by any means, or (ii) distributed to any person that is not an employee, officer, director, or authorized agent of the recipient.

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