A few readers have expressed concern about their recent investment performance. In most cases, these investors are holding a sensible, low cost, globally diversified portfolio of index funds ranging from conservative (40% stocks, 60% bonds) to balanced (60% stocks, 40% bonds). One reader said:
“Psychologically, it’s tough to put money in when returns have been so low.”
When you invest in a passive portfolio that tracks broad market indexes you can expect to earn market returns minus a small fee. This is far and away the best and most reliable way to invest for the long term.
But sometimes market returns can be disappointing in the short term. Investors might be experiencing that right now. In fact, if you’ve recently moved away from actively managed funds or stock picking to embrace a portfolio of passive index funds, you might be wondering if that was a wise decision.
Market returns have been dismal this year compared to returns from the previous two years. But context matters. FP Canada’s projection and assumption guidelines suggest future expected returns of approximately 4.78% per year for a global balanced portfolio.
Meanwhile, an actual global balanced portfolio represented by Vanguard’s VBAL and iShares’ XBAL returned about 15% in 2019 and 10.5% in 2020. Even a global conservative (40/60) portfolio returned about 12% in 2019 and 10% in 2020. This is highly unusual.
|Vanguard Conservative ETF||VCNS||-0.82%||9.41%||12.10%|
|iShares Core Conservative ETF||XCNS||-0.86%||10.33%||n/a|
|Vanguard Balanced ETF||VBAL||1.12%||10.24%||14.91%|
|iShares Core Balanced ETF||XBAL||1.41%||10.58%||15.19%|
|Vanguard Growth ETF||VGRO||3.11%||10.89%||17.84%|
|iShares Core Growth ETF||XGRO||3.01%||11.42%||17.96%|
|Vanguard Equity ETF||VEQT||5.56%||11.29%||n/a|
|iShares Core Equity ETF||XEQT||4.76%||11.71%||n/a|
A reasonable investor adjusts his or her expectations of future returns. After all, a conservative or balanced portfolio certainly won’t continue to deliver double-digit annual returns forever.
Indeed, reasonable investors should accept market returns and not fuss over short-term fluctuations or periods of underperformance.
But if your framing around index funds is about performance chasing rather than diversifying and keeping costs low then it’s going to be hard to wrap your head around accepting market returns – especially when returns have been poor.
This has been my fear all along about persuading so many investors to switch to indexing. Will they calmly stay in their seats when markets inevitably fall? Or will they panic and move on to a different strategy?
Let me state this as clearly as I can.
Market fluctuations are normal. Markets fall from time to time. Often by a lot. That’s a feature of your index funds, not a bug.
If you hold an asset allocation ETF, or invest through a robo advisor, your portfolio will automatically rebalance, selling what has gone up and buying more of what’s gone down.
Investors in the accumulation stage should embrace falling prices, since they can pick up more shares with every new contribution.
To quote Warren Buffett:
“If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall.”
The strong past performance of conservative and balanced portfolios have clouded our view of what reasonable market returns look like. We’re used to double-digit gains, so now we’re upset that the return on a 50/50 balanced portfolio is flat year-to-date (it’s only May, by the way).
Ignore the urge to do something with your portfolio – like it’s an appliance that needs repair. Stick to your plan.
Impatient investors might try to juice their returns by dialing up the risk and adding more stocks. That’s a mistake. Stocks add more volatility to your portfolio, so if you’re unhappy with flat returns in the short-term, you’re going to really hate it when stocks fall by 20% or more, taking your portfolio down for the ride. See March 2020 for proof of volatility in action.
So, if you’re invested in a low cost, globally diversified, and risk appropriate portfolio, congratulations on a perfectly sensible approach. You’re not doing anything wrong. Be patient, keep adding new money regularly, and try your best to ignore daily market movements.