The Annual (Return) Quilting Bee: A Visual Representation of Asset Returns
There are two striking things about the returns of investment markets over the last decade or so. One is the consistently steady performance of the US stock market. Although not necessarily the top performing market every year, the US stock market has done very well since emerging from the Great Financial Crisis of 2007-2009. Second, and this is perpetually the case, it appears, is that the top performing asset category in any given year is exceedingly difficult to predict.
A helpful illustration of this second point is what is sometimes referred to as a quilt and at other times as a periodic table. You can find a US-oriented version from Ben Carlson, writer of the blog A Wealth of Common Sense and co-host of the podcast Animal Spirits. He refers to it as an Asset Allocation Quilt. Another version, this one oriented more toward Canadian investors, can be found at The Measure of a Plan website. The “periodic table” on this site goes all the way back to 1985, so it’s very helpful from a longer-term perspective.
The Periodic Table of Annual Returns for Canadians
The periodic table I used is from a long-time investment analyst and writer, who has often appeared in MoneySense and The Globe and Mail, Norm Rothery. He maintains the Stingy Investor website, where he has posted his version: The Periodic Table of Annual Returns for Canadians. Warning: As you will see below, Rothery sets a fairly vibrant colour palette.
Below is the colour key coding of the table. I have also added the ticker symbols for the most commonly held Exchange-Traded Funds (ETF) and Mutual Funds (MF), in case you want to explore these categories as options for your own investment portfolio. These are not recommendations, may not be available to you, and should be investigated thoroughly before any purchase decisions are made.
Returning to the table, do you notice anything about the twelve different asset classes year after year? Trace the TSX, for example. In 2010, the TSX Composite finished in a respectable second place. A year later it was tenth out of the twelve categories. In 2015 (and again in 2018) it was the worst performer while in 2016 it was the best performer. If nothing else, this should help investors to remember that “home bias,” the tendency to invest a disproportionate amount of your money in your home country, is often detrimental to your investment returns.
Constructing a Globally Diversified Portfolio
In practice, I suspect that most investors do not make use of all twelve of these categories. For a globally diversified investment portfolio, five components are often considered sufficient: bonds, Canadian stocks, US stocks, stocks of international (non-North American) developed markets, and emerging markets stocks. These are the components of the recently developed and increasingly popular “asset allocation” ETFs that are produced by Vanguard, iShares, and BMO to name the three biggest. The information provided by the periodic table helps us to see how a portfolio might do over time.
The following tables show the results of an 80/20 portfolio with two strategies at work. The first 80/20 table reflects the purchase of a $5,000 portfolio, broken down according to the percentages under the TARGET column. The initial purchases are made at the end of 2009. After that, no further purchases are made and no rebalancing is done.
The second table reflects the same start, but at the end of each year, the portfolio is rebalanced back toward its target allocation. I assume that there are no frictional costs like bid-ask spreads, fees, or commissions.
There are several points to notice. First, the portfolio that is not rebalanced outperforms the portfolio that is rebalanced annually. This is to be expected. The point of rebalancing is not necessarily to outperform but to set a particular asset allocation that is consistent with the amount of risk that you are willing and able to take on.
The second thing I noticed was how much the balance among the assets had shifted over the measured period in the portfolio that was not rebalanced. This next table shows how much of a shift had occurred.
The results of rebalancing were not entirely a loss. In 2011, when the stock markets around the world were quite poor, rebalancing helped for both 2011 and 2012. However, the clear winner over most of the last decade has been the US stock market, represented here by the Wilshire 5000 index, one of the indices that seeks to track the total US stock market. While bonds dropped to 55% of their target allocation, the US stocks were up by 168% of their target.
The third point of interest for me was the fact that the Canadian stock market has done the worst of the four equity indices. The TSX Composite finished at 68% of its target, while Emerging Markets finished barely ahead at 70% of its original target. The second best was 78% of target for the EAFE index, representing the markets of the developed countries of the world.
Forget about Rebalancing?
One of the lessons that I would not take from this is that you should simply forget about rebalancing. The US stock market has done remarkably well over the last several years, but that is not a guarantee that such performance will continue. Investors set a target allocation because they are willing to take a certain degree of risk. Allowing that allocation to drift over time means your risk is changing. In this instance, you are losing the protective quality of bonds, which tend to zig when stocks zag. By default, you are also putting down a bigger and bigger bet on US stocks year after year.
Finally, rebalancing also enforces a certain discipline. Each time you rebalance, you are selling a portion of the higher-performing asset to buy more of the lower-performing one. In effect, on a regular basis you are buying low and selling high. While it may hurt to do so, in the long run, you should be getting your expected return while lowering your risk.
If you would like to discuss this or other posts, connect on Facebook, Twitter or LinkedIn.
Click here to contact me for an appointment.
In uncertain economic times, you may be interested in a half-hour no-cost, no-obligation financial planning conversation with me. It’s called FINPLAN30 and the range of topics is wide open. Click here to sign up for a free session.
Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, tax, or legal decisions.
Image by Candace Hunter from Pixabay