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It's Hard To Profit From Pessimism

August 30, 2019
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Let's say you knew in advance that 2008 was going to be the worst year for stocks since the 1930s.  Would you still want to own stocks? Your guess would probably be no.  You might think that Gold would be a better haven for the ensuing 50%+ meltdown.  Your guess would be wrong.  

Buying and holding Gold since 2008 has dramatically underperformed a diversified stock portfolio, despite performing better early on.  The chart below shows the growth of $1M in two separate allocations.  Portfolio 1, the blue line, is the Dimensional Equity Balanced Strategy, a globally diversified, small/value tilted stock portfolio.  Portfolio 2 is the Gold ETF, GLD.  Portfolio 1 ended with over $2M, Portfolio 2 had just $1.6M at the end of July.

Both portfolios had considerable volatility and experienced losses of over -40% (stocks in 2008, Gold in recent years).  But stocks provided a much better reward for the risk, even if we start with their worst decline since the Great Depression.

Understandably, not all investors want the risk that comes with an all-stock allocation.  Many retirees prefer a smoother ride and are willing to accept lower returns as a consequence.  But even if the is the case, Gold doesn't fit.  You're better off reducing your diversified stock allocation and including short-term bonds for a more balanced portfolio.  Selling a portion of your short-term bonds for cash flow during bear markets offers an excellent alternative to liquidating stocks at temporarily depressed prices.

The image above reproduces our hypothetical prior example, but this time Portfolio 1 is the Dimensional Normal Balanced Strategy, a 60/40 mix of the Equity Balanced Strategy and short-term, high quality global bonds.  The overall risk is reduced compared to the all-stock allocation shown previously, but it still comes out ahead of Gold.

No one can predict what lies ahead for the stock or bond markets in the coming months.  But a review of history shows that diversified stock portfolios have been resilient in the face of adversity and have typically outperformed other asset classes, even when the timing has been less than ideal.  If you want less risk and are willing to accept a lower return, adding short-term bonds is your best bet.  The alternative approach, trying to sidestep downturns and avoid the inevitable losses, often fares far worse.  

It's hard to profit from pessimism.

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Source of data: Portfolio Visualizer.

  • Dimensional Equity Balanced Strategy = 20% DFA US Large Company Fund, 20% DFA US Large Value Fund, 10% DFA US Microcap Fund, 10% DFA US Small Value Fund, 10% DFA Real Estate Securities Fund, 10% DFA Int'l Value Fund, 5% DFA Int'l Small Cap Fund, 5% DFA Int'l Small Value Fund, 3% DFA Emerging Markets Fund, 3% DFA Emerging Markets Value Fund, 4% DFA Emerging Markets Small Cap Fund; rebalanced monthly.
  • Dimensional Normal Balanced Strategy = 12% DFA US Large Company Fund, 12% DFA US Large Value Fund, 6% DFA US Microcap Fund, 6% DFA US Small Value Fund, 6% DFA Real Estate Securities Fund, 6% DFA Int'l Value Fund, 3% DFA Int'l Small Cap Fund, 3% DFA Int'l Small Value Fund, 1.8% DFA Emerging Markets Fund, 1.8% DFA Emerging Markets Value Fund, 2.44% DFA Emerging Markets Small Cap Fund;10% DFA One-Year Bond, 10% DFA Two-Year Global Bond, 10% DFA Short-term Gov't Bond, 10% DFA Five-Year Global Bond; rebalanced monthly.
  • Balanced Strategy Allocations and data provided by Dimensional Fund Advisors.

Past performance is not a guarantee of future results. Index and mutual fund performance includes reinvestment of dividends and other earnings but does not reflect the deduction of investment advisory fees or other expenses except where noted. This content is provided for informational purposes and should not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services.