How Did the Stock Pickers Do in 2011?

Source: Capital Pixel

My last post presented results on the BlackRock standard portfolio which is basically 65% stocks/35% bonds and cash equivalents.  It returned approximately 1.6% for the year.  To me, it's a good benchmark against which to measure investment performance.  After all, it is simple and very easy to exectute.  It takes very little time, is well diversified and low cost, and it is an approach recommended by many very knowledgeable long-time students of the market, including Malkiel, Ellis, Bogle, Hallam, and Bernstein.  Even Warren Buffett says that most investors, individuals as well as professionals, should use index funds.

As it happens, I am conversing with a potential client whose inherited IRA dropped 11% last year.  His broker (not a registered investment advisor) invested the IRA in funds that have a front load of 5% and expense ratios averaging 1.22%.

I gave him a cursory overview of why that was horrendous performance and why he should be in low-cost index funds.  He ran it past his broker who responded that he was in funds that had a superior 10-year record versus the S&P 500.

This brings us to a point of where there is a bit of odor in the room ,but we can't tell where it is coming from.  Down 11% but in great funds!  The potential client is a professional fireman and, unfortunately, not a professional odor spotter.  A long-term track record would seem to be obviously important, especially when presented with multi-colored graphs on glossy paper.  What isn't intuitive is that, if one has 30 funds ,it is rather easy to pick out the best 5 which probably outperformed the market. It  is sort of like having 30 people flip a coin 10 times and finding the 4 or 5 that got the most "heads."

The question most people would not know to ask is "what does the evidence show on consistency of performance."  And the evidence is clear - there is no consistency.  The best coin flippers tend not to outperform in the next round, as is the case with active fund managers.  In fact, the lack of consistency is also revealed as top investors fall to the bottom.  In recent years, we've seen Miller, Paulson, Berkowitz, and even Bill Gross humbled by Mr. Market.  Unfortunately, what people don't see are the investors whose retirement assets are put in jeopardy because they over invested with the "best and the brightest."

A related question arises as to the stock-picking ability of analysts.  Sometimes I run into people who claim " Yeah but I've got a guy...".  Here is an interesting piece written by Brett Arends, "Should you buy Wall Street's top stocks for 2012?", where he examined the top picks by analysts (paid the big bucks) out of the S&P 500.  They were - 3.5% in 2011.  The S&P 500 index was flat for the year and earned the dividend.

Imagine paying 5% up front and then 1.2% management fee to these analysts.  Sure, some will come out on top but, over the long run, the odds decreased.  You'd be better off putting your money with the top coin flippers in my opinion.

Disclosure:  Investors should do their own research and consult a professional before making investment decisions.  The information here is for educational purposes only.

2011 Performance - BlackRock Standard Diversified Portfolio

HAPPY NEW YEAR EVERYONE!!!  I had a wonderful New Year's in Ocean City, Maryland with my wife.  The weather was absolutely great.  We stayed at a fun place where the rocking chairs are comfortable and the house wine is perfect.

The view of the surfers from the deck was excellent.  I could appreciate them because I spent a day surfing in Galveston, Texas in the Gulf of Mexico years ago.  I only made it on the board once or twice, but it was fun!

Our stay in Ocean City was great place to welcome the New Year.  I hope everyone's New Year was as enjoyable.

Now, back to the real world.

A useful research piece on market performance  is the "Asset Class Returns: A 20-Year Snapshot" table produced by BlackRock and discussed at Cedar Financial Advisors.  It shows annual asset class returns, color-coded, ranked so that investors can easily see the best-performing and worst-performing sectors for each year over the 20-year period.

Similar so-called periodic tables of investment returns are produced by others, but the BlackRock table is unique in its inclusion of a diversified portfolio.  The diversified portfolio is an excellent benchmark for many DIY investors to consider, in my opinion.  It is comprised of low-cost, index exchange traded funds.  The 20-year annualized return of the portfolio was 8.89% for the 20-year period ended 12/31/2010.

2011
 
2011 was undoubtedly a challenging year for many investors.  Those swayed by their emotions had plenty of opportunities to make portfolio-busting shifts.  Most of those who had a plan and stuck with it probably came out OK.  The table shows performance achieved by various sectors as represented by low-cost ETFs and the weights of the various sectors.  Europe was the obvious drag on the portfolio as evidenced by the -12.17% return on EFA.  Once again, the overall bond market was the knight in shining armor, with AGG returning +7.58%.  Overall the portfolio returned +1.61% for the year. Although below the rate of inflation, many investors would have been satisfied with this return.  For those with the funds parked in money funds or even short-term certificates of deposit, this performance would have been acceptable.

Source:  Data from Morningstar/BlackRock Diversified Portfolio

CLICK IMAGE TO ENLARGE  As a point of reference, the S&P 500 returned 2.11% for the year.




Accumulators vs. Decumulators

My clients include both accumulators and decumulators.  Accumulators seek to take advantage of dollar-cost averaging.  They are contributing a fixed amount to their 401ks, etc.  Down markets benefit them as they buy at lower prices.  Decumulators, on the other hand, can unambiguously get hurt in a down market if they don't have a plan to draw down their nest egg.  Dollar-cost averaging can seriously harm the retiree drawing funds from their nest egg.

2011 was fairly neutral for both as long as no rash portfolio shifts were made.  The following shows the S&P 500 as represented by the SPY ETF:

Source: Yahoo/Finance

 CLICK TO ENLARGE As shown in the chart, U.S. stocks tried to trend upwards over the first half of the year and then hit a serious air pocket from which it again trended upwards.  The second half of the year was extremely volatile, as headlines out of Europe dominated even economic data showing the U.S. economy was showing some life.  In this market, dollar-cost averaging resulted in paying more for shares early in the year compared to where the market ended up.  Still, if investors held in and no shifts were made, shares were accumulated over the later half at attractive prices as the market rebounded strongly in the 3rd quarter.  In other words, dollar-cost averaging paid off over the later 6 months.

By the same token, the decumulator, drawing what is essentially a paycheck off of the nest egg, who had sufficient funds to ride out the downturn participated in the upturn.  In contrast, the decumulator who sold equities to fund cash needs during the first half of the year partially missed out on the rebound.  To stave off this negative impact, those living off their nest egg should have, at a minimum, 9 months in cash and a portfolio yield  dividends and interest) of at least 2.4% to replenish required payments.

Disclosure:  This information is intended for educational purposes.  Individuals should do their own research or consult a professional before making investment decisions.