Market Commentary

2019 ANNUAL RETURNS FOR SELECTED INDICES

PERIOD ENDING: December 31, 2019

The winners kept on winning in 2019. The decade (2010-2019) for U.S. stocks and, in particular, U.S. growth stocks, has been stellar. However, we’d caution against the siren call of plowing money into what has recently worked. That’s especially true after a great year. Rather, we’d suggest that after a year when everything worked; it’s likely that some kind of correction or at least added volatility is lurking around the corner.

Nevertheless, forecasting the future is usually a humbling experience. It’s just too hard to get consistently right. We do not have a crystal ball that tells with any certainty when, where, and how much the market may bounce around. Therefore, keep calm, remain diversified and stay invested.

What’s remarkable is that despite a strong run for US stocks and bonds over the last ten years, a diversified portfolio still ends up ahead over twenty years. That’s because the first decade of returns was zero. That’s right, U.S. stocks don’t just go straight up. It was during the tech bubble that large sized U.S. companies posted incredible returns. When that bubble burst, it took six years to set another new high. As soon as the market rebounded, it collapsed again during the Great Financial Crisis. It took until 2012 for the market to return to new highs. And since 2009, owning large sized US stocks has been an elevator ride to the top floor.

Twenty years may seem like a long time, but investing is a marathon, not a sprint. Even the recently retired will have a twenty to thirty-year time horizon for their portfolios. A quality process, patience and discipline need to be a component in every investment plan. It’s best to stick to sensible long-term investing principles.

Remaining steadfastly diversified is a key tenet to investment success. Though, a properly diversified portfolio doesn’t always feel rewarding. That’s because a well-diversified portfolio will tend to always own both the best and the worst performers. As illustrated below, a diversified portfolio loses money when the broad market drops and doesn’t make as much on the way back up. The key is that the diversified portfolio doesn’t lose as much as the index.

Simple rules, like owning a globally diversified portfolio, can create successful outcomes.

The philosophical goals we set for portfolios are:

• To create efficient, globally diversified, low-overlap portfolios.
• To have a deep understanding and conviction in what is owned.
• To employ a value investing methodology to help introduce a margin of safety in our decision making.
• To use common sense – not purely academic – thoughts on risk.
• To tilt toward areas of the market that are expected to have higher long-term rates of return.
• To match the investment portfolio to the goals and objectives of a personalized financial plan.
• To have a long-term outlook, discipline and patience.
• To control for frictions and avoid unnecessary tax and cost drag.

We believe any client of any adviser should require that their adviser invest their personal assets based on the same principles in the same or comparable securities that they do for you. This is my attempt to demonstrate an alignment of investment interests. Rather than continue to tell you what to do, I am going to show you what I own.

Disclosure: The following is my portfolio and is specific to me and my situation. That means the securities, philosophy, and process employed may be the same, but the weights and concentrations may not be. Every portfolio should be matched to the individual goals and objectives of each unique client and be part of a financial plan that integrates your own personal financial situation. The portfolio described below may change at any time and without notice. All of this means that the following is for informational purposes only and should not be considered financial advice. Thus, please do not copy this portfolio without consultation from a professional.

Here goes… At a high level, the starting point for my portfolio is the global stock market. My interpretation is based on DFA’s Global Market Breakdown. As of the last update on September 30, 2019, the global stock markets compared to my allocation looked like this:

I try to be fully invested all the time. I also try to invest in areas that have historically shown, or are expected to show, higher future returns. That’s why my portfolio is more tilted toward smaller sized companies as well as emerging market stocks. It also attempts to tilt toward value. Value investing is simply the pursuit to own stocks at a bargain. These extra tilts are an active bet away from the market portfolio.

Using a tool provided by BlackRock, my portfolio (blue bars) is overweight in value and size, and underweight in low volatility relative to the global stock market (yellow lines).

Given the difference in construction, the return profile over time will deviate and be different than the broad averages. With a portfolio like this, though, I am my own worst enemy. There will be times when the portfolio is incredibly rewarding, but also incredibly terrifying at times. And, unless small value stocks are performing well (not true recently), it will likely lag the broad market.

Drilling deeper into the portfolio, I invest in two buckets. The first bucket is my “Retirement Accounts”. These are investments located in tax-advantaged accounts like an IRA. The second is my “Taxable Account”. These are investments that are subject to annual taxes on dividends, interest, and capital gains.

My Retirement Accounts are made up of IRA’s. Since taxes are not owed on gains as long as the funds stay within the account, this is where I own less tax-efficient strategies. These strategies also tend to be more expensive. In general, the funds are run by idiosyncratic managers that provide global diversification, active stock picking and potential excess returns. They are also concentrated, contrarian, small, and perform detailed research. The objective is to entrust capital to professional asset managers that run a process I can understand and have conviction in and then I let them do their thing.

Investments owned in my Retirement Accounts are:

My Retirement Accounts make up the majority of my investments at approximately 75%. They are invested for the long-term and the accounts are always fully invested. Most of the active bets are made within these accounts.

The other piece of my investments is a Taxable Account. I have been primarily diverting new cash to an automated portfolio solution. In other words, it’s a robo-advisor. It should be low cost and tax-efficient. Success is measured on how well it can match the global stock while providing a low tax bill every year. It is also a real-world portfolio with actual costs that I use to benchmark the returns of all my other investable assets.

Investments owned in the robo-advisor are:

My Taxable Account makes up 25% of my investments. I send money to the robo to quickly and efficiently “buy all the stocks”. Cash is immediately invested and I don’t have to worry about it. And, thanks to the elimination of trading fees at places like Schwab, now I can transact without a charge.

In addition to the automated portfolio, I also own a handful of individual stocks such as Berkshire Hathaway and Brookfield Asset Management.

Overall, I have tried to appropriately locate investments into accounts where they will generate the lowest frictions as well as high expected returns. For instance, mutual funds are owned inside retirement accounts and ETFs are owned in taxable accounts. And, for example, I take extra tilts toward small-sized companies, value stocks and global exposure. If investments are selected well, they should end up ahead of the robo-portfolio after fees and taxes.

Astute readers will also notice that I don’t own any bonds. Bonds tend to be used to reduce portfolio risk. So, while risk management is extremely important, it can mean different things to different people. To mitigate possible impairments or shortfalls, I try to avoid areas that have a high chance of failure. The best course, then, is to for me to have a deep understanding of what I own and its future expectations. As an additional risk management technique, I have an emergency fund at a local bank. It’s adequate enough to protect from shocks and enables me to maintain a high expected return portfolio.

My total portfolio rebalances once per year, which only occurs after we’ve taken care of every client. That does not mean we’re not reviewing and continuously underwriting every investment because we are. It means I do not let myself become distracted by how my portfolio is doing every second. That helps to reinforce patience.

Lastly, I want to reiterate that my investment portfolio is integrated with my own personal financial plan. It does not exist in isolation. My investments make sense for me in regard to my education savings plan, my retirement plan, my tax plan, my insurance plan, and my estate plan. My financial plan helps me take a long-term view on how I manage my money and taxes to support retirement goals. I review it annually, along with my portfolio.

The point of this mailing is show that I eat my own cooking and risk my own money in the same way and with the same investments as we recommend to clients.

Happy New Year!

Adam K. Wright, CFA, CFP®