After talking with a number of clients and friends in the past couple of weeks it became apparent that a breakdown of YTD stock market performance would be informative. There are major pronounced differences currently in the various stock categories. An explanation of these differences could illuminate why certain portfolios have gone up (or down) more than others.
Please note that this discussion is not meant to minimize the importance of performance. Performance is critical; however, the time frame of performance evaluation and the concept of progress toward achieving goals are even more critical to successful investing.
Consider the following year-to-date data points as of earlier this week:
- Dow Jones (30 US major companies) -5.4%
- S&P 500 +1.4%
- Nasdaq +19.32%
- Russell 2000 (smallest companies) -10.7%
What are the takeaways of this data?
- Depending on what types of stocks dominate a portfolio, or what types of stocks or funds are held in a 401k account vs. a globally diversified portfolio, performance will differ vastly!
- Understanding the current makeup of the Dow Jones, S&P 500, Nasdaq, and Russell 2000 explains the performance differences:
- In the Dow Jones, there are a total of 30 large companies with a different type of weighting than the S&P 500 and Nasdaq.
- The S&P 500 index is the 500 largest US companies with just five (5) companies making up nearly 20% of the index, Microsoft, Apple, Amazon, Google (Alphabet), Facebook.
- These same 5 companies are part of the Nasdaq index.
- The Nasdaq Composite index is made of 4,000 large and small companies (many so small they are not tracked by major indexes) with the index dominated by technology companies. This year, the Nasdaq Composite index’s performance has benefited from the performance of the “Fab 5” mentioned above plus technology being on fire amidst the coronavirus.
- Note that the Russell 2000 index is made up of 2,000 of the smallest US companies. (There are another 1,000+ larger companies not in this index that make up 98% of the US market.) Owning smaller companies adds A LOT of volatility to a portfolio. In addition, owning smaller companies adds the opportunity for long-term growth in a portfolio at a cheaper relative price. In 2020, so far, small companies went down far more than larger companies and have not recouped as much of their decline. Most recently small companies have sped up their recovery (Please ask me about this).
A well-diversified portfolio will own ALL of these components – notably with less dominance by the “Fab 5”. Plus, a diversified portfolio will own in a range of 15% to 25% of non-US companies. In recent prior years owning non-US companies has helped overall performance – not every year but in a handful of years and periods of time. In 2020, so far, international diversification has held back performance versus a US-only portfolio.
Three final points:
- The concept of time frame for performance evaluation cannot be emphasized enough. In this particular 6-7-month period of 2020 which has been historically significant in several major ways (!) technology has been one of the only games in town for positive performance – see the four data points in green above.
- A well-diversified portfolio will have periods of “under-performance” in times of out-sized dominance by narrow groups of stocks or companies.
- “Out-performance” is a relative term. Out-performance relative to what? To goals? Or to a hand-picked sector of high-performing stocks? Evaluating a total portfolio versus one asset category – large technology stocks – is not a valid benchmark for the long-term. Remember the dotcom bust? Lots of those companies never recovered.
Performance measured versus achievement of short-, intermediate- and long-term goals is a valid benchmark. Awareness of overall risk and global diversification is critical for the short- and long-term. A portfolio containing a measured allocation to large, small, technology and non-tech plus non-US companies, has not derailed progress toward overall goals.