My clients have heard me say it over and over again: investors who are patient and disciplined are rewarded over the long term. That is why we construct broadly diversified portfolios designed with each client’s long-term goals and needs in mind. Instead of trying to chase the next “hot” stock or figure out which sector will be the top performer in any given period, we establish a portfolio with assets distributed efficiently across all sectors and then we allow the markets to work for clients, rather than against them.
One of the best ways to understand this principle is by looking at a chart called the Callan Periodic Table of Investments. Visually similar to the familiar periodic table of the elements that we all remember (sort of) from high school chemistry, the Callan table groups all the major investment types—from cash to emerging market stocks—and charts their returns over varying periods of time. For example, the following illustration shows the Callan table for each single-year period from 2001–2020, with returns shown for all the asset types. The highest-performing assets are at the top, and the lowest at the bottom. Each color block represents a different type of asset.
Source: Callan.com
So, in this chart, the top-performing sector in 2001 was US fixed income (bonds), with a total return for the year of 8.43%. The worst-performing sector that year was stocks in developing countries, at -21.4%. In 2020, the top performer was small-capitalization stock (19.96%), while real estate was at the bottom of the heap (-9.04%).
Is there an obvious pattern, from one year to the next? (Hint: if you said “no,” you would be correct). The Callan Periodic Table illustrates visually what I tell my clients: no one can predict the price movement of any asset group during a particular period with any reasonable accuracy. This year’s winner may be next year’s loser. This is why we build broadly diversified portfolios.
But when we stretch the time frame, something interesting begins to happen. For example, take a look at the returns exhibited by holding assets for 15-year periods, as analyzed by researchers Stephen Huxley and Brent Burns:
Source: Huxley and Burns, “The Illusion of Extrapolating Randomness from Periodic Tables”
When the holding period for assets is extended from a single year to 15 years, a pattern, missing from the single-year analysis, begins to emerge. In the chart above, the top positions claimed by the best performers over the various 15-year periods are, by and large, occupied by equity investments—stocks. In fact, most of the top positions are small-capitalization value stocks: smaller companies whose shares are trading at a lower price relative to their book value.
What would happen if we extended the holding period even more—say, to 30 years? Let’s take a look:
Source: Huxley and Burns
By this point, the pattern is clear: equity investments—and particularly small-capitalization and value stocks—will generally outperform other asset classes over the long haul.
What does this mean for investors? First, it means that your portfolio must be constructed with an appropriate time frame in mind. For a younger person who is investing for retirement in twenty to thirty years, it will be important to allocate a larger percentage of the asset mix to equity investments in order to achieve the type of long-term growth needed to provide for a secure retirement. For those who are closer to retirement—who do not have the luxury of a long time frame to recover from a period of falling equity prices—it will usually be more important to allocate a larger portion of the asset mix toward more conservative investments like bonds or, in certain cases, real estate. That is why each client’s portfolio and diversification strategy must be uniquely designed with their age, goals, and risk tolerance in mind.
But over longer time frames, equities can be expected to outperform most other asset classes. That is why, even for more conservative investors, it is usually advisable to have some portion of assets allocated to stocks, simply to ensure that the portfolio will continue to have growth characteristics sufficient to provide for the longer life spans that are more and more typical.
The most important takeaway, though, is the value of patience and discipline. When your portfolio is properly diversified, you will be best served by sticking to your long-term plan. Investors who are able to “tune out the noise” and stay their course will, in the majority of cases, do well over the long term.
Making decisions about your investment strategy can be confusing, especially if you are not familiar with the basic principles of the markets. As a fiduciary financial advisor, my job is to provide my clients with the reliable, time- and market-tested information they need to become informed investors. To learn more, click here to read my whitepaper, “The Informed Investor.”
Stay Diversified, Stay YOUR Course!
