Well, it’s finally happened. The high-flying growth stocks of 2020 have crashed hard. Everyone wanted more of these stocks in their portfolios in 2020 and 2021. Yet after the current drop, prices for many of them are back to pre-pandemic levels, even though sales have grown 10X and some of these technologies are a staple of our everyday lives. It’s important to remember that rockets have two stages. They go up, and when they run out of fuel, they come back down.
Despite a very volatile start to the year, broad returns don’t look so bad. Though, bonds have corrected right alongside stocks as inflation concerns rise and interest rates go up. It’s hard to believe that a mere 15 months ago the 30-year mortgage rate was at 2.67%. Today, it’s 3.85%. For perspective, with the higher rates, a borrower today will pay an extra $55,983 in interest over the life of a 30-year $240,000 mortgage. That’s all while there are fewer available homes to purchase, and they are still at sky high prices! But maybe that’s about to change too.
Nevertheless, as long as you have a good financial plan, with a sound investment strategy to meet your goals, just stay the course. As always, knowing what you own is critical in your investment plan.
The importance of due diligence
Diversification matters. So does asset allocation. Asset allocation is determining the right mix of stocks, bonds and cash to use for your portfolio. Each asset class has its own risk and reward attributes, and when combined together, this is diversification. Stocks and bonds are key components to every investor’s investment plan; however, once you know how much you need to own in stocks, then you need to pick the right investment vehicles to use.
Picking an investment product for your portfolio is known as investment selection. Researching available options is hard work, and requires due diligence. Almost every possible combination is available to investors nowadays, but all this choice can be hard to sort through.
Some say that research and active stock picking leads to better risk adjusted returns. Others say, “don’t bother”, just own low-cost total market index funds. Both strategies can work well for an investor on their way to meeting their goals. But in either case, due diligence is important, as every investor should know what they own, why they own it and how they’re using it.
What we think matters for fund selection
Whether it’s an index fund or an active fund, we look to understand the same variables. It’s what we call the 5 Ps: Philosophy, Process, People, Portfolio and Performance. Each one matters and can be a determinant of success or failure.
When it comes to index funds, we look at two critical variables above all else: the underlying index and fees. Which index you use can make a big difference in return pattern. For example, when choosing between US small stock exposures you need to determine if you want to include unprofitable companies or not, and how big, exactly, a small company is. Then, lowest expense wins.
When it comes to active funds, deep fundamental research and the size of the fund matter. Some analysts suggest that the excess return potential from active management comes from the intersection of opportunity, skill and temperament. We’d add to that concentration. An active fund that looks like its benchmark, but with higher fees, is likely to lose over time. In fact, that’s exactly what the data says.
US stock funds have an underwhelming track record
S&P Dow Jones Indices publishes an annual report known as SPIVA®, which tracks the progress and success, net of fees, of active fund managers. Since it began publishing results in 2002, SPIVA has shown that in any given year, and over the long-term, only 10-20% active funds outperform their comparative index funds.
Big picture: about 60% of active funds underperform the total US stock market in any given year. One of the hardest places to invest is in US Large Cap stocks, where competition is fierce and returns are determined by only a small number of stocks. Active managers enjoy higher success rates when picking among small company stocks, but it’s by no means easier, since there are literally thousands of stocks to sift through.
Therefore, when selecting actively managed assets to include in your portfolio, research and due diligence play a critical role. That same diligence, however, is also required if your investment plan uses index funds. And the actual index being tracked matters a lot too.
A quick note on cybersecurity
The current geopolitical situation is creating an evolving threat around internet safety. Since we all use email, Google, and the internet every day, for almost every purpose, we wanted to share some resources and information to help you stay safe.
First, Charles Schwab is our qualified custodian for client assets. They work tirelessly to keep your assets and personal information safe. They also have a dedicated Client Learning Center you can access which provides security updates and steps you can take to protect yourself online.
Second, in conjunction with Schwab, we’ve been increasingly adopting encrypted eSignatures as part of our paperwork process. Once over the initial learning curve, it’s been a great way to quickly and securely process forms. Additionally, we encrypt outbound emails containing anything remotely close to sensitive information. While we can share files securely through Right Capital, this year we will work to install a secure share point for additional easy document sharing.
We take our duty to our clients seriously, to prepare you for the future, and to invest according to your plans. Central to our commitment is a focus on the security and protection of your sensitive data.
So, here’s to the rest of 2022, and one we hope is full of insight, progress and prosperity!