After experiencing the Great Recession of late 2008 and early 2009, investors may have questioned the merits associated with diversification. With most asset classes experiencing significant declines, the most seasoned of investors were forced to reevaluate their investment plans. Those who panicked and sold out of growth assets (stocks, REIT’s, commodities, high yield bonds) in late 2008 or early 2009 were disappointed to miss out on the strong rally that has occurred over the past 21 months. While hindsight is often 20/20, the Great Recession was another illustration that “Time In The Market” is often more important than “Timing the Market.“ The chart below is a good illustration of that point.
Investment advisors often hear stories from prospective clients about the money that was lost by investing in stocks, real estate or other assets. What is interesting about these stories is that they are often quite similar in nature. The novice investor seeks to chase gains in an asset class and enters at or near the top of the market. An example of this is the investor who purchases tech stocks in 1999 or banking stocks or real estate in the mid 2000’s. These investors were chasing gains that had already occurred within these asset classes. Chasing gains is often the quickest way to deplete an investor’s principal. A more prudent way to invest one’s nest egg is to diversify among a variety of asset classes preferably those that exhibit low or possibly negative correlation. This would result in an investor benefitting in most market environments by at least having one asset class with gains.
The chart below clearly depicts that some asset classes are “in favor” while others are “out of favor” for extended periods of time. During the 1970’s, the country was faced with the OPEC oil embargo resulting in gas shortages and long lines at service stations throughout the country. During this inflationary period, commodities were the best performing asset class. In the 1980’s, Japan’s market capitalization accounted for a majority of the foreign stock index (MSCI EAFE) and Japan’s housing boom led to this asset class outperforming all others during that decade. The decline in Japanese stock market which was known at the time as the “Lost Decade” coincided with the technology boom in the U.S. during the 1990’s. During this time, U.S. stocks dramatically outperformed all other asset classes. During the 2000’s, commercial real estate as measured by the Real Estate Investment Trust (REIT) Index outperformed all other asset classes even after the dramatic declines experienced during the fall of 2008 and spring of 2009.
What is the lesson learned from this chart? The lesson relates to the fact that it is extremely difficult if not impossible to predict which asset class will outperform all others during this decade. Exposure in some degree to all these asset classes based upon your unique risk tolerance level would enable you to have a portion of your assets in the best performing asset class for the coming decade. Whether you are a do-it-yourself investor or currently work with a financial advisor, please ensure that your portfolio matches your short and long-term investment objectives as well as your risk tolerance level. In conclusion, the patient investor will tell you that it is often “time in” the market as opposed to “timing” the market that will allow you to reach your financial goals.
Asset Class 1970’s 1980’s 1990’s 2000’s 2010
Commodities 21.3% 10.7% 3.9% 5.1% 9.0%
Foreign Stocks 8.8 22.0 7.0 1.6 8.2
U.S. Stocks 5.9 17.5 18.2 -1.0 15.1
Real Estate (REIT’S) n/a 12.5 6.8 10.2 26.9
U.S. Bonds 7.5 12.4 7.7 6.3 6.5
Source: Morningstar, NAREIT, Standard & Poors