This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today's article is by Craig Israelsen, Ph.D., creator of the 7Twelve portfolio, consultant to 7Twelve Advisors, LLC and executive-in-residence in the Financial Planning Program at Utah Valley University.
Building a diversified investment portfolio can be painful for ego-based investors. Every holding won’t be the winner at the end of each year.
But that’s the point, isn’t it? Since we don’t know what the “winning” asset class will be the start of each year, we diversify across many.
Therefore, it shouldn’t be surprising that a diversified portfolio (using mutual funds and/or ETFs) will have a mishmash of returns each year—some better than others. This reality shouldn’t be a source of pain. Rather, it should reflect that we actually built a genuinely diversified portfolio.
If all our portfolio components (say, ETFs) had a similar return in a given year (let’s say a good return), then it’s clear we didn’t build a diversified portfolio that included ETFs that behaved differently (think low correlation portfolio ingredients here).
So, what do diversified returns look like? Shown below are the annual returns for 12 asset classes over the past 20 years. The 12 asset classes are based on the design of the 7Twelve® Portfolio and are represented by 12 indexes: five are equity indexes; three are indexes representing “diversifiers”; and four indexes are fixed income.
Since 2002, 45% of the time one of the equity indexes was the best annual performer, 40% of the time one of the diversifier indexes was the winner, and 15% of the time one of the fixed income indexes was the annual standout. The best-performing index is highlighted each year. Over the past 20 years, diversifiers and fixed income were the annual winners more often than equity.
One thing becomes quite clear: Good luck predicting the next year’s winner. Ultimate message: Stay diversified across multiple asset classes (with a healthy dose of “diversifiers”) and contentedly live with the fact that we can’t predict the future.
A 20-Year View Of The Index-Based 7Twelve® Portfolio
(For a larger view, click on the image above)