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Optimism Is The Only Realism

August 03, 2018
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Monday will mark the seven-year anniversary of Standard & Poor's lowering the credit rating on the United States for the first time in recorded history.  If ever there was a "this time it's different" moment, it would have been this.  The Wall Street Journal article above was generally ominous, as were most news outlets, and in the extreme suggested that it could trigger another "Lehman moment" (the bankruptcy of one of the nations biggest Investment Banks in the Fall of 2008 that sent stocks spiraling over 40% in the ensuing five months).  My memory of this episode was investors and advisors alike were clamoring to reposition portfolios to take advantage of this new reality.

Where do you invest in a world where the most commonly-cited safe haven is no longer considered "safe"?  One common alternative to traditional assets like stocks and bonds was Gold.  Fans of precious metals argue that Gold is not only a hedge against unexpected inflation (that's debatable) but also a haven against political upheaval and market calamity.

How have the last seven years played out?

The graph below tells the tale.  Portfolio #1 in BLUE represents an investment in the Gold ETF (GLD).  It didn't protect you from anything unless you were worried about making money.  $10,000 invested in Gold in September 2011 is worth 35% less today, just $6,527.  Portfolio #2* in RED is a globally diversified stock portfolio example, which shrugged off the debt downgrade as well as the 2016 correction and grew at a compound rate of +12.8% per year through July.  $10,000 invested increased to over $23,000.  Portfolio #3** in YELLOW is a balanced portfolio example for investors who don't wish to take the full brunt of stock market swings -- it holds 65% in the diversified stock portfolio but also includes 35% in a short-term bond fund.  Portfolio #3 didn't match the returns of the all-stock mix, but at +9.0% per year, it struck the right combination of growth and stability for more cautious investors or for those who are taking distributions from their portfolio while also providing significant appreciation ($10,000 grew to over $18,000).

While Portfolio #2 and #3 have different components, they are alike in one crucial way: they have significant allocations to stocks and represent a vote of confidence and an expression of optimism about the future of the global economy and capital markets.  They fluctuate in the short-term, sometimes significantly, and react poorly to unexpected panics and economic declines.  But they've always bounced back.  

Gold, on the other hand, has barely kept pace with inflation over the last several decades yet has fluctuated as much as stocks in the process.  Gold is prone to short periods of exuberance followed by long stretches of negative returns.  Gold saw a decline of almost -43% during this period, a loss that rivals the worst bear markets for stocks in recent history.  But unlike stocks, Gold continues to languish in price and isn't even close to recapturing its previous highs.  Gold is more like a put option on optimism; it's a wager that our best days are behind us, that the world will soon tumble into permanent chaos and represents an insurance policy for pessimists.  Maybe there's some hyperbole in those comments, but you get the idea.

History teaches us a different lesson.  Long-term optimism is the only realism.  You should invest accordingly.

*21% DFA US Large Company Fund, 21% DFA US Large Value Fund, 28% DFA US Small Value Fund, 18% DFA Int'l Value Fund, 12% DFA Int'l Small Value Fund, rebalanced annually.

**13.5% DFA US Large Company Fund, 13.5% DFA US Large Value Fund, 18% DFA US Small Value Fund, 12% DFA Int'l Value Fund, 8% DFA Int'l Small Value Fund,, 35% DFA Five-Year Global Bond Fund, rebalanced annually.

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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.