Financial markets have been relatively calm so far in 2014: US stocks have gained about 1-2%, total international stocks are up almost 3%, and total return on US bonds has been about 3.5% (I'm using returns from Vanguard's Total Stock Market Index, Total International Stock Index, and Total Bond Market Index funds). There was a mild correction in late January with US stocks down about 5% and international stocks down about 7%, but other than that, stocks have been mostly bouncing around the +/-2% range.
By contrast, 2013 was a big up year for stocks and a down year for bonds. US stocks returned more than 30%, international stocks returned about 15%, and the Total Bond Market index fund lost about 2%. US stocks got an extra boost from small-cap stocks which returned about 38% in 2013. International stocks were dragged down by emerging markets which lost about 5% in 2013, while developed international markets gained about 22%. Bond fund losses, caused by generally rising interest rates, were proportional to interest-rate risk (average maturity/duration of fund), with Vanguard's Inflation-Protected Securities fund losing almost 9% and its Long-Term Government Bond Index fund down about 12.5%.
Of course one-year or year-to-date (YTD) returns aren't very important to long-term investors, but since people tend to feel the pain of losses twice as much as the pleasure of gains, perhaps it doesn't hurt to pause and celebrate a year of strong returns. Next time stocks drop by 20% or more, perhaps it will be useful to remember that they went up a lot before that (and most likely will go up a lot after that).
It's also important to remember that it's the performance of the entire portfolio that matters much more than the performance of the individual parts of the portfolio. An investor with a balanced portfolio of stock and bond funds shouldn't worry that bonds and emerging market stocks had losses in 2013. Consider the portfolio of a young investor with 80% in stocks and 20% in bonds, and with 70% of the stocks in the total US stock market and 30% in the total international stock market; i.e., 56% total US stock market, 24% total international stock market, and 20% total US bond market. The 2013 return for this portfolio was about 20%, which is calculated by adding the weighted returns of the portfolio components: 56% x 30% + 24% x 15% + 20% x -2% = 20%.
It's not rational for he investor with a well-diversified, balanced portfolio to be envious of the 38% return of small-cap stocks or depressed by the negative return for bonds. The nature of a diversified portfolio is that some components of the portfolio will do better than other parts over any given time period, and which parts do better is likely to change over time. As already noted, US total bond market index has gained about 3.5% so far in 2014; during the same time, small-cap US stocks have lost about 1.5%.
Looking at the slightly longer term, here are some ten-year average annual returns:
By contrast, 2013 was a big up year for stocks and a down year for bonds. US stocks returned more than 30%, international stocks returned about 15%, and the Total Bond Market index fund lost about 2%. US stocks got an extra boost from small-cap stocks which returned about 38% in 2013. International stocks were dragged down by emerging markets which lost about 5% in 2013, while developed international markets gained about 22%. Bond fund losses, caused by generally rising interest rates, were proportional to interest-rate risk (average maturity/duration of fund), with Vanguard's Inflation-Protected Securities fund losing almost 9% and its Long-Term Government Bond Index fund down about 12.5%.
Of course one-year or year-to-date (YTD) returns aren't very important to long-term investors, but since people tend to feel the pain of losses twice as much as the pleasure of gains, perhaps it doesn't hurt to pause and celebrate a year of strong returns. Next time stocks drop by 20% or more, perhaps it will be useful to remember that they went up a lot before that (and most likely will go up a lot after that).
It's also important to remember that it's the performance of the entire portfolio that matters much more than the performance of the individual parts of the portfolio. An investor with a balanced portfolio of stock and bond funds shouldn't worry that bonds and emerging market stocks had losses in 2013. Consider the portfolio of a young investor with 80% in stocks and 20% in bonds, and with 70% of the stocks in the total US stock market and 30% in the total international stock market; i.e., 56% total US stock market, 24% total international stock market, and 20% total US bond market. The 2013 return for this portfolio was about 20%, which is calculated by adding the weighted returns of the portfolio components: 56% x 30% + 24% x 15% + 20% x -2% = 20%.
It's not rational for he investor with a well-diversified, balanced portfolio to be envious of the 38% return of small-cap stocks or depressed by the negative return for bonds. The nature of a diversified portfolio is that some components of the portfolio will do better than other parts over any given time period, and which parts do better is likely to change over time. As already noted, US total bond market index has gained about 3.5% so far in 2014; during the same time, small-cap US stocks have lost about 1.5%.
Looking at the slightly longer term, here are some ten-year average annual returns:
- Total US Stocks: 8.3%
- Small-cap US stocks: 10.2%
- Total International Stocks: 7.3%
- Total Bond Market: 4.8%
You may recall the highly publicized "lost decade" for stocks after the financial crisis in late 2008 and early 2009. Those who have continued to invest in a simple, balanced portfolio of low-cost index funds during and after those rough times have been well rewarded.
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