April 18, 2017
The Picture of Investment Diversity
Most people see multicolored chaos in the chart below, which is a visual representation of the returns each year to various types of investments.
Strauts, like most investment professionals, knows the Callan Periodic Table of Investment Returns. It has been around for 20 years and was just updated with 2016’s returns. Here’s how to read it. A colored square is assigned to each type of stock- and bond-market index. For example, the Bloomberg Barclay’s Aggregate (Agg) bond index is bright green, and the Standard & Poor’s 500 stock index is khaki green – the boxes also give each index’s return for each year.
Stock and bond returns are not well correlated, so investing in both provides diversification that reduces risk and can even out the overall portfolio’s returns from year to year. Now step back and look at the entire chart. This quickly makes clear that the pattern of colors is also unpredictable, further illustrating the benefit of diversification.
In truth, the Callan Periodic table “is not completely random,” Strauts said. For example, one discernable pattern is that annual returns to the risky MSCI index of stocks in developing countries (the orange box) are usually at the top or bottom of a column – and rarely in the middle. The index was up 19 percent in 2010 and down 18 percent in 2011.
“To guess whether it’s going to be at the top or bottom each year – well, who knows,” he said. (Morningstar has its own version of Callan’s table.)
Strauts said investors should keep things simple. “That means keeping a diversified portfolio – not buying just one thing and calling it simple. That’s actually risky.” As the chart also shows.
That’s why he likes target date funds (TDFs), which have become popular in employee retirement savings plans in recent years.
TDFs invest in a diversified portfolio, and the portfolio’s risk level is reduced as the worker approaches his or her retirement date. The overall return to the TDF is reported to the investor. “You don’t see the big ups and downs as much, even though they’re still happening” in the individual investment classes that underlie the TDF, Strauts said.
This also reduces or eliminates the temptation to move money out of an investment fund when it’s losing money. Pulling money out in down years, he said, is “probably the opposite of what you should do.”
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