2014 becomes 2015, a.k.a., “What now?”

Investment management clients of Financial Planning Associates, Inc., please note that your 4th quarter reports have been posted to your secure web folders.

The table below will provide some insight concerning the rewards (or not) enjoyed (or not) by investors in 12 standard investment categories during the 4th quarter of 2014, and during the full year.

It was a pretty good year if you held only US large cap stocks, and a great year if you held only biotech shares or US REITs.  If, however, you were more broadly diversified your total return in 2014 was likely to have been modest.

So, since US large cap stocks (and US REITs, and biotechs) were the winners in 2014 a reasonable investor might ask whether she should increase her holdings in these asset categories in 2015? Will this pattern repeat?

This question was studied by Dr. Eugene Fama, who won the Nobel Prize in Economics in 2013 for his work. What he found was that the return for a given asset class in a given year implies nothing about the return the following year.¹ It is not uncommon for last year’s losers to become this year’s winners. Therefore, given the demonstrated lack of year-to-year predictability, an investor’s most prudent approach is to hold a well-diversified portfolio consistent with her goals and risk tolerance. This is the strategy that we employ for the benefit of our clients. It is supported by the weight of both academic research and real-world experience.

Dr. Craig L. Israelsen is a frequent contributor to professional journals in the world of finance, and for a number of years he was a faculty member at the University of Missouri in Columbia, MO. His research has been cited in the  Journal of Financial Planning, Journal of Asset Management (U.K.), Journal of Performance Measurement, Journal of Family and Economic Issues, Christian Science Monitor, Wall Street Journal, Newsweek, Forbes, Smart Money Magazine, Kiplinger Retirement Report, Advisor Perspectives, and Dow Jones Market Watch. Primary among his research interests is the analysis of mutual funds and the design of investment portfolios.²

His most recent book is titled 7Twelve: A Diversified Investment Portfolio with a Plan (John Wiley & Sons, 2010). In this book he proposes the use of 12 mutual funds or exchange traded products to fully represent 7 asset classes. This is the implementation strategy that I have been using for the benefit of my clients for quite a few years now.³  You can read more about Dr. Israelsen’s portfolio strategy here.

Some people bring happiness wherever they go. Others bring happiness whenever they go.

¹ “The Behavior of Stock Market Prices”, Journal of Business, January, 1965.

² From Dr. Israelsen’s website: http://www.7twelveportfolio.com/AboutUs.html

³ The broad asset classes are the same, and the specific exchange traded product differences are few. Dr. Israelsen advocates a distinction between natural resources and commodities. We make a distinction among international developed bonds, emerging market bonds, and international inflation-adjusted bonds. Also, we generally use fundamentally weighted indexes.

Note: Thanks to Dr. Thomas Eyssell of the University of Missouri at St Louis for comments on an earlier draft of this manuscript.