Socks or Stocks
“Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.” –Warren Buffet
We’ve received many calls this past quarter regarding the markets; not just stock markets, but bond markets as well. Some calls pertain to the U.S. stock market and the new highs in the Dow. Others relate to the selloff in the bond market due to long term interest rates increasing.
As you’ll see in the chart below regarding YTD performance for most of the funds in our portfolio, the emerging market stock fund is down more than 10% while U.S. stocks are up over 15%. What does this mean? Well, in my eyes, this is a good thing. In fact, the picture below is about as pretty as one painted by Picasso (if you like Picasso). When we talk about diversification, this is exactly what you want to see; half of the funds are up while the other half are down. U.S. stocks just happen to be the ones up this year.
Also, notice the master limited partnership (MLP) funds. They were some of the worst-performing funds last year and people were asking why the heck we had the investments in our portfolio. However, this year, they have one of the best investment returns. This is a consistent theme in the history of stock markets and, most likely, you will see the same thing next year with this year’s bottom performers.
Thus, if you stick to your annual rebalancing – buying what is selling at a discount or marked down (like emerging market stocks) and selling what has done well (like U.S. stocks) – your portfolio will benefit significantly. As I always remind clients, we are focusing on what your portfolio will do during the next 5-10 years; the year-to-year changes are insignificant to a prudent investor. Don’t fall into the trap many investors did in the 1990s when the value of U.S. large cap and technology stocks significantly increased while most other investments (like international stocks) were stagnant. Investors during that time who didn’t follow a well-diversified rebalancing strategy were hurt permanently by the year 2000 crash.
Regarding bonds, the 10-year treasury bond yield has increased from around 1.7 to 2.5% over the past couple months. This is a significant move in interest rates, so we’ve fielded many questions around its effect on our bond portfolio. (Bond prices drop when interest rates go up.) Our bond portfolio favors a buy-and-hold strategy while also holding mainly short-term bonds. As a result, this large move only caused a temporary drop in our bond portfolio of around 2%.
Similarly, although we expect rates to eventually move up further, you should always have bonds in your portfolio for diversification purposes and for protection against large stock-market drops. Bonds are different from stocks because they typically don’t lose value permanently unless the country, city or company goes bankrupt. If you hold on to bonds despite a drop in price, you will get your money back plus interest. Our portfolio contains over 5,000 companies and government-backed bonds, so one – or even several – bankruptcies (like what you saw with the city of Detroit’s bonds recently) will have minimal impact on your portfolio.
Have other questions about the market or our portfolio strategy? Your Redwood financial advisors are happy to assist you.
Also, be sure to read about Abigail Soren, Redwood’s newest financial planner, who is quickly (but not surprisingly) becoming a strong member of our team.
Enjoy the rest of your summer.
Lane Steinberger MBA, CFA, CFP®
Partner, Chief Investment Officer