Why do our clients at Carson Wealth not want us to provide investment performance like the S&P 500 Index? To answer this, it is important to understand the risks associated with a particular investment. Placing all of one’s assets in an index such as the S&P 500, which is concentrated in large-cap US companies, is a high-risk and volatile strategy. When working with clients, we gauge each individual’s capacity for accepting risk. We have an established process that begins with collecting responses to risk tolerance questionnaires. We then have discussions about their cash flow needs and determine how much risk each has experienced before becoming a client.
We have not had a single client indicate that he or she is willing to experience declines of 50% in value. Spoiler alert: accepting this amount of volatility is absolutely unnecessary and could likely provide disastrous results. In fact, over the last 25 years, the S&P 500 index has experienced losses of at least 50% on two occasions—once during 2000-2002 and then again in 2008. During these challenging periods, investors can rightfully lose patience with this investment, often selling after it has fallen in an attempt to protect what is left. Furthermore, this less diversified strategy often creates a cycle of market timing, and ultimately, underperformance.
At Carson Wealth, our approach is based upon Nobel Prize-winning research, which emphasizes a more diversified approach across multiple asset classes. This cutting-edge academic research focuses on what should appear obvious but is often forgotten — that market timing generally does not work! It also proved that being appropriately diversified provides the best chance for success and can be a superior approach to investing. This strategy is one we have implemented for clients over 35 years so it is time-tested as well.
In terms of investment returns, if an investor experiences a 50% loss, it requires a 100% gain in order to recover all that is lost, which can be a tall order. Returning to the examples where these declines occurred in 2000-2002 and 2008, in both cases it took over five years for the S&P 500 to recover what was lost. If the investor was retired, and living on the portfolio, he could have been forced into selling this investment while values were down. This breaks the cardinal rule of investing, which is to never sell low, since it does not allow the opportunity for a recovery.
A traditional concept of investing is that more risk provides an opportunity for higher returns (and larger losses). When comparing our client portfolios to the S&P 500 Index, our strategies typically provide the desired effect of reducing volatility (i.e. are less risky). In other words, they have an opportunity to “win by not losing”. With less risk, expectations should be for investment performance to be lower than the S&P 500. Interestingly, however, there are several extended periods where even with less risk, the diversified portfolio generates higher rates of returns, such as from 2000-2009. This occurs when the S&P 500 Index is not the best performing index, which is often the case. In fact, in the decade of the 1970s and the early 2000s investing in a money market fund would have provided a better return than the S&P 500 Index! A diversified portfolio would have significantly outperformed both of these, however.
A crystal ball would obviously be helpful when it comes to investing. Why didn’t investors place all of their money in Google before it grew, or Apple after they re-hired Steve Jobs? Even investing in the NASDAQ, which is an index of mostly technology stocks, would have been a great opportunity after the declines experienced in 2002 and 2008. However, without a crystal ball, and without the benefit of hindsight, it is best to limit risks and focus on avoiding an outcome where little or no investment return is generated for an extended period of time. Very real financial challenges could result where a retiree may need to go back to work later in life or reduce the standard of living, or both.
For comparison, the typical worst-case scenario for a diversified portfolio is that it underperforms an index for a period of time. However, most importantly, when this relative underperformance occurs, while it sometimes may not feel great, it is unlikely to result in jeopardizing one’s retirement goals.
In conclusion, it is essentially a trade-off: does Carson Wealth speculate on a portfolio with one particular index, such as the S&P 500, and risk a significant loss? Or do we lower volatility with multiple asset classes and know that we can pursue a competitive rate of return and not jeopardize retirement goals? Clients come to us to pursue the latter!
The views stated in this article are not necessarily the opinion of CWM, LLC. and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
The S&P 500 is an index of 505 stocks chosen for market size, liquidity and industry grouping (among other factors) designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large cap universe. The NASDAQ Composite Index includes all domestic and international based common type stocks listed on The NASDAQ Stock Market. The NASDAQ Composite Index includes over 2,500 companies, spanning all 11 sector groups.
