“The key to successful investing is not predicting the future, but looking at the present with clarity.” This observation by Dr. David Kelly, CFA, Chief Global Strategist, J.P. Morgan Funds, offers particular wisdom today. Among other things, investors wonder if the US Federal Reserve will increase interest rates, what the People’s Bank of China’s next move might be, and whether the current market volatility will persist. We don’t know. And that uncertainty can rattle investors, resulting in emotionally-charged, reactionary investment decisions.
Admittedly, it’s a challenge for investors to stay focused on a long-term investment plan given how increasingly divergent macroeconomic policies, currency swings in China and general geopolitical conflicts dominate the headlines. The key is to stay up-to-date with this news, but to understand that overreacting to short-term news and the ensuing market movements often results in investors making the big mistake of vastly altering their asset allocation. Then, the portfolio’s new risk/reward profile can put their short-and long-term goals in real jeopardy.
It’s important to realize that no matter how sever the daily or weekly volatility, that these returns are tempered when viewed over longer holding periods. Take a look at the chart below. In spite of intra-year declines averaging 14.2%, the S&P 500 still posted positive returns in 27 of the last 35 years.
J.P. Morgan’s “Investing with Composure in Volatile Markets” also makes the point that diversified, regularly rebalanced portfolios have typically resulted in higher Sharpe ratios than other singular equity asset classes over 10-, 15- and 20-year time horizons. Specifically, over the last 10 years, a diversified “asset allocation portfolio” with the following weights: 25% in the S&P 500, 10% in the Russell 2000, 15% in the MSCI EAFE, 5% in the MSCI EME, 25% in the Barclays Capital Aggregate, 5% in the Barclays 1-3m Treasury, 5% in the CS/Tremont Equity Market Neutral Index, 5% in the Bloomberg Commodity Index and 5% in the NAREIT Equity REIT Index has generated annualized returns of 6.5%, comparing favorably to other major asset classes. More importantly, the returns were achieved with lower volatility than other equity asset classes. Over this 10-year period, the asset allocation portfolio’s volatility was two-thirds that of the overall stock market and almost one-third that of emerging market equities.
That smoother ride in and of itself can keep investors from making poor decisions when the road ahead looks uncertain. And so, today, rather than change with the market winds, we continue to advise investors to stay diversified and focus on the long-term.