Let's say, a year ago, you were looking at the losses mounting in your investment portfolio and you decided to "reassess" your strategy. Maybe so much in stocks wasn't warranted? Maybe bonds, despite their historically low interest rates, deserved a (greater) role because of their safety in bear markets? You'll remember that in mid-March of 2020, it seemed that the stock decline had only just begun. How did switching portfolios work out?
Looking back, over the last year, we see that a well-diversified, all-stock portfolio (DFA Global Equity Fund -- DGEIX) has gained over 81%. Every $100,000 invested is now worth $181,159. What about a balanced 60% stock and 40% bond allocation? The DFA Global 60/40 Allocation Fund -- DGSIX -- has gained just +45%. That same $100,000 would have only grown to $145,526, or only about 1/2 as much! Missing out on a 35% gain in the last year is the equivalent of the cost of a full-time financial advisor who charges 1% a year...for 35 years! Ouch.
But it's not just all-stock allocations that suffered from an ill-timed switch. What if you held the 60/40 allocation but decided a much more "conservative" 25% stock and 75% bond allocation was more sensible? Over the last 12 months, the DFA Global 25/75 Allocation Fund -- DGTSX -- gained only +19%, and $100,000 in it grew to only $118,949. That's a difference of almost $30,000 less compared to the 60/40 allocation. That switch would have been almost as costly as the one from 100% to 60% stocks.
The same math works for ultra-conservative investors who got out of stocks completely. Sitting in cash over the last year, represented below by the DFA One-Year Fixed Income Fund -- DFIHX -- earned you effectively nothing. $100,000 invested is still worth $100k before some rounding. The move completely out of stocks from just 25% in equities cost you almost $20,000 on a $100,000 investment. Given the exceedingly low return potential for bonds and bond-heavy portfolios, that's a loss you'll never recoup.
The extreme case is where the all-stock investor bailed on stocks entirely and has been sitting in cash for the last year. This move missed an 80% gain and over $80,000 on every $100,000 they had invested. That is the equivalent of the cost of a full-time financial advisor who charges 1% a year...for almost three generations! Triple ouch!!!
Changing your stock and bond allocation wasn't the only move you could have made last year, or were possibly considering. Remember how badly small cap value stocks had been fairing? From 2017 through 2019, small cap value badly lagged the overall market, and then when it plummeted in the first quarter of 2020, small cap value lost even more! If you weren't second guessing your small cap value tilt last year, you wouldn't be human. But switching your allocation would have been disasterous.
Over the last 12 months now, the gold-standard for small cap value stock exposure -- the DFA US Small Cap Value Fund (DFSVX), has returned +131%. Every $100,000 invested in small cap value is now worth $231,644. What if you had been looking at recent-year returns and noticed that the Vanguard Small Cap Value Index -- VISVX -- had done better? If you (or your advisor!) understood the dynamics of asset class and index construction, and realized or remembered that Vanguard's fund holds noticeably larger and less "value-ey" stocks, you would have concluded that it wasn't a "better" fund despite better recent performance. It just held fewer true small cap value companies and this watered down approach was bound to do better when small value stocks were the worst performers in the market. You wouldn't have made a change. But if all you did was look at recent performance, you would have made the swap. And paid a hefty price.
The Vanguard Small Value Index is up +105% in the last 12 months, over 25% less than DFA. $100,000 in VISVX has grown to $205,136; not bad, but not nearly as much as in DFSVX. Making the switch cost you the equivalent of 25 years worth of full-time financial advisory fees at 1% a year. All of the sudden, Vanguard's low-cost obsession doesn't seem so inexpensive?
Switching out of small cap value stocks entirely would have been even worse. It certainly felt safer and more secure to just invest in the large cap, growth-oriented Vanguard Total Stock Index last year and not worry about small cap value stocks at all. But as you know, safety and lower returns are inextricably linked. The Vanguard Total Stock Index Fund -- VTSMX -- only gained +77% in the last 12 months, over 40% less than small cap value. $100,000 invested in VTSMX returned $177,462, $54K less than in the DFA US Small Cap Value Fund! Missing out on that return is the equivalent of paying a full-time financial advisor 1% per year for your entire retirement and most of your beneficiaries subsequent retirement!
Making portfolio changes based on recent market conditions is almost always a mistake. Why? You're usually inclined to move away from an asset class or asset allocation that has been doing poorly and towards one that has been doing much better. But by the time this becomes a serious consideration for you, the momentum behind those movements is probably close to ending and reversing. No trend lasts forever in investing and short-term returns are mostly random. When the music stops playing you'll usually be the one left standing, and as the examples above illustrate, the costs can be enormous.
In just the last year, common portfolio mistakes investors made -- reducing or eliminating stocks in general and small cap value stocks in particular, have cost them the equivalent of a lifetime or more of advisory fees! Said another way, if all an advisor does for you over the course of your multi-decade relationship is to keep you from making one of these extremely costly mistakes, they will have paid for their entire lifetime fee! All the additional services (financial planning, portfolio design, ongoing investment management, etc.) and the time you saved not having to mess with your money will have been free!
There are times when an investment change makes sense, but that's a topic for another day. For this one, just remember and remind your fellow investors -- there's peril in switching your portfolio.
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.