Fundamentals of Investing
The investment universe is bigger than you might expect, and you have quite a few choices when it comes to putting a financial and investment plan into action. In the end, saving and investing are the fundamental means towards achieving your financial goals—and freeing up your time to focus on the areas of life you value most.
The good thing? Your advisor is here to help. They are committed to helping you with the planning and education you need to get focused on what matters most in enacting your plan.
The Foundation of Every Portfolio
Before building a portfolio to help you achieve your plan, you’ll want to understand the choices you have. The basic levers in portfolio design are stocks and bonds. They are the two main investment options available to investors, as well as the primary methods through which public companies raise money to invest in their operations.
When buying shares of a company, you hope to capture a share of their future profits, but when buying bonds you’re counting on being repaid the money loaned, with interest.
Stocks
Also referred to as equities, stocks are considered a purchase of ownership in, and in turn, a share of a company. Since future cash flows and profits are highly uncertain, stocks tend to be a riskier and potentially more lucrative investment option.
Bonds
Also called fixed income, bonds can be considered loans to governments or a company in exchange for interest payments or additional income. Since most bonds have defined cash flows, they tend to be less risky than many other investments.
Time Has Proven the Value of Investing
When investing, your primary goal is to grow your accounts to fund your financial goals. Historically, while both bond and stock investments have outpaced inflation, and given the higher level of risk, stocks have delivered significantly more growth over the long term.
Disclosure
Source: Ken French Data Library, Dimensional.
Hypothetical value of $1 invested at the end of 1927 and kept invested through December 31, 2023. Assumes reinvestment of income and no transaction costs or taxes. Total returns in U.S. dollars. Past performance is no guarantee of future results.
Stocks are represented by the Fama/French Total US Market Research Index Portfolio, which is an unmanaged index of stocks of all U.S. companies operating on the NYSE, AMEX, or NASDAQ. Bonds are represented by Five-Year U.S. Treasury bonds, from Dimensional. Inflation is represented by the Consumer Price Index (CPI). The CPI reflects monthly data on changes in the prices paid by urban consumers for a representative basket of goods and services, not seasonally adjusted. The Fama/French Total U.S. Market Research Index Portfolio Index and the Five-Year Treasury Bond Index are unmanaged baskets of securities that investors cannot directly invest in. Index performance does not reflect the fees or expenses associated with the management of an actual portfolio. Risks associated with investing in stocks potentially include increased volatility (up and down movement in the value of your assets) and loss of principal. Treasury bonds are backed by the U.S. government and guaranteed as to the timely payment of principal and interest. Treasury bonds are subject to interest rate and inflation risk and their values will decline as interest rates rise.
These charts illustrate a graphical representation of the hypothetical growth of a dollar invested in the indexes mentioned above. Time period chosen for comparison purposes only. Information from sources deemed reliable, but its accuracy cannot be guaranteed. This information should not be considered as a demonstration of actual performance results or actual trading using client assets and should not be interpreted as such. The results may not reflect the impact that material economic and market factors may have had on the advisor’s decision-making in managing actual client accounts.
The Ebb and Flow of Stock Market Investing
Stock returns have been impressive, but they’re not consistent.
Despite the growth, investing is filled with ups and downs, and even the best years go through bad periods. In fact, stocks decline one month out of every three, and you can expect a pullback of 20% or more once every 4 years. This is known as volatility, and it’s why you should expect a bumpy road towards portfolio growth.
Discover why we believe it’s time in the markets, not timing the markets, that matters.
Disclosure
Data for the U.S. Market declines from the Ken French Data Library. U.S. Market is a value weighted return of all CRSP firms incorporated in the U.S. and listed on the NYSE, AMEX, or NASDAQ. Over the 97-year period from January 1927 through December 2023, U.S. stocks had an intra-year decline of 20% or more 25 times, which is roughly once every 4 years. U.S. stocks had an intra-year decline of 10% or more 65 times, which is roughly once every 18 months. U.S. stocks were down 433 of the 1,164 months over that same period, or slightly more than once every 3 months. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio nor do indices represent results of actual trading. Information from sources deemed reliable, but its accuracy cannot be guaranteed. Performance is historical and does not guarantee future results. Index total return includes reinvestment of dividends and capital gains.
The Power of Time
Time is one of the most important variables in your plan and plays a key role in your investment strategy. Whether you’ve been investing for five years or fifty, the power of time is and continually remains central to an effective strategy.
Time in the market is also important and as we just saw, stock markets can be volatile. Part of long-term planning is being realistic about your ability to stay invested through market volatility. And although it can be pretty tempting to try to time the market, just a few mistakes can have a big impact on the growth of your portfolio.
Disclosure
Source: Ken French Data Library, Morningstar Direct 2022.
Information for the first five bars is based on the total return of U.S. Stocks over the last 30 years, from Jan. 1, 1994 to Dec. 31, 2023. Bonds are represented by 5-Year Treasury Bonds from Jan. 1, 1994, to Dec. 31, 2023. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio nor do indices represent results of actual trading. Information from sources deemed reliable, but its accuracy cannot be guaranteed. Performance is historical and does not guarantee future results. Total return includes reinvestment of dividends and capital gains.
Seeing the Whole Investment World
When you see the financial news, they are typically reporting on the Dow Jones Industrial Average (DJIA), the S&P 500 or the NASDAQ—what does that really mean? These are key indexes, or proxies for the overall “market”. The DJIA comprises only 30 stocks that are considered core to the U.S. market activity while the S&P 500 consists of the largest 500 companies in the United States. The NASDAQ tends to focus on more technology-focused companies.
While the U.S. boasts the largest stock market, overlooking other global markets may present missed opportunity. There is so much more to investing than the S&P 500—and lately a few large companies have come to dominate the index. The top 5 names in the S&P 500 account for nearly 25% of the overall index (as of December 31, 2023).
Breaking Down the Indexes
These well-known indexes generally only track larger companies. For example, the S&P 500 tracks the largest companies in the U.S., and most of those have done relatively well over recent periods, meaning they’re more expensive than other companies that you can buy.
This is the concept of investment style and is a key component in your overall strategy.
However, did you know that in addition to the roughly 500 largest stocks, there are over 3,000 other companies you can invest in in the U.S.?
Although the S&P 500 is a good proxy for how stocks have performed in the U.S., there’s a world of opportunity beyond those large companies. And it’s hard to predict which types of stocks will have the best returns, especially over the next year.
Disclosure
Source: Dimensional Fund Advisors, as of December 31, 2022. Many funds, even those tracking the total international market, may not invest in all publicly companies publicly traded in each country, and may make case-by-case determinations about the suitability of investing in each emerging market, making considerations that include local market accessibility, government stability, and property rights before making investments. China A-shares that are available for foreign investors through the Hong Kong Stock Connect program are included in China, an emerging market. Many nations were not considered in the totals. Totals may not equal 100% due to rounding. For educational purposes only. This should not be considered investment advice. Diversification neither assures a profit nor guarantees against loss in a declining market.
Chasing Missed Opportunity
Many investors suffer from recency bias and overemphasize companies or regions that have done well recently. However, historically we see no discernible pattern that suggests we can predict which countries will do the best.
In some years, U.S. companies do well. In other years, companies in Europe do well. In other years, we see companies in emerging markets do well. And we have seen plenty of times where U.S. companies lagged their international counterparts, even over five-year periods.
Regional Returns (%) 1994-2023
Disclosure
Source: Ken French Data Library. For a full breakdown of the index construction methodology, see the page: https://mba.tuck.dartmouth.edu/pages/faculty/ken.french/Data_Library/int_index_port_formed.html
The asset class returns are based on the value-weight return of each region, presented in U.S. dollars. The returns on the index portfolios are constructed by averaging the returns on the country portfolios, and the market return for each country includes all firms with book-to-market data.
The 5-Year return numbers reflect the five-year annualized return of each asset class.
Asia Pacific Companies reflects the value-weight returns of companies domiciled in Australia, Hong Kong, Japan, Malaysia, New Zealand, and Singapore.
Emerging Markets Companies reflects the value-weight returns of companies domiciled in Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Malaysia, Mexico, Pakistan, Peru, Philippines, Poland, Qatar, Saudi Arabia, South Africa, South Korea, Taiwan, Thailand, Turkey, United Arab Emirates.
European Companies reflects the value-weight returns of companies domiciled in Austria, Belgium, Switzerland, Germany, Spain, France, Great Britain, Greece, Ireland, Italy, Netherlands, and Portugal.
Scandinavian Companies reflects the value-weight returns of companies domiciled in Denmark, Finland, Norway, and Sweden.
U.S. companies reflects the value-weight returns of companies domiciled in the United States.
All returns include the reinvestment of dividends. Foreign securities involve additional risks, including foreign currency changes, political risks, foreign taxes, and different methods of accounting and financial reporting. Emerging markets involve additional risks, including, but not limited to, currency fluctuation, political instability, foreign taxes, and different methods of accounting and financial reporting.
Returns Aren’t Predictable
Evidence-driven investing looks at diversification from other angles as well. We can sort companies based on their size and value (how the public pricing of the company compares to its book value). These are called asset classes.
Asset classes are categories of investments that tend to share characteristics and respond similarly to market and economic events. Asset classes extend beyond stocks to bonds and other investments, and they form an extremely important building block in investing.
The challenge here is: can you find a pattern in the colors?
No? That’s why we invest in a broad range of asset classes—to diversify and balance out returns. While no one knows who might outperform in the future—we know that investing in companies all around the world, both big and small, is the starting point for any good portfolio.
Asset Class Returns (%) 1994-2023
Disclosure
The U.S. asset classes are based on the returns of stocks of all U.S. companies operating on the NYSE, AMEX, or NASDAQ. The asset class portfolios, which are constructed at the end of each June, are the intersections of 2 portfolios formed on size (market equity, ME) and 3 portfolios formed on the ratio of book equity to market equity (B/M). The size breakpoint for year t is the median NYSE market equity at the end of June of year t, where t is the displayed year. B/M for June of year t is the book equity for the last fiscal year end in t-1 divided by Market Equity for December of t-1. The B/M breakpoints are the 30th and 70th NYSE percentiles.
U.S. Large Growth represents the value-weight return of the stocks with a total market capitalization higher than the median value and having a B/M in the lowest 30% of the market.
U.S. Large Value represents the value-weight return of the stocks with a total market capitalization higher than the median value and having a B/M in the highest 30% of the market.
U.S. Small Growth represents the value-weight return of the stocks with a total market capitalization less than the median value and having a B/M in the lowest 30% of the market.
U.S. Small Value represents the value-weight return of the stocks with a total market capitalization less than the median value and having a B/M in the highest 30% of the market.
International asset class returns are based on the value-weight return of each region, presented in U.S. dollars. Countries included in the International returns include Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and United Kingdom. Large stocks are those in the top 90% of June market cap for the region, and small stocks are those in the bottom 10%. The B/M breakpoints for big and small stocks in a region are the 30th and 70th percentiles of B/M for the big stocks of the region.
International Large Growth represents the average value-weight return of the stocks in each region that are in the highest 90% of market cap for the region and have a B/M in the lowest 30% of the region.
International Large Value represents the average value-weight return of the stocks in each region that are in the highest 90% of market cap for the region and have a B/M in the highest 30% of the region.
International Small Growth represents the average value-weight return of the stocks in each region that are in the lowest 10% of market cap for the region and have a B/M in the lowest 30% of the region.
International Small Value represents the average value-weight return of the stocks in each region that are in the lowest 10% of market cap for the region and have a B/M in the highest 30% of the region.
Emerging Markets Stocks are represented by the average value-weight return of all emerging market countries, presented in U.S. dollars. Emerging markets countries currently include: Argentina, Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Malaysia, Mexico, Pakistan, Peru, Philippines, Poland, Qatar, Russia, Saudi Arabia, South Africa, South Korea, Taiwan, Thailand, Turkey, United Arab Emirates.
Real Estate is represented by the Morningstar U.S. Real Estate Total Return Index.
U.S. Intermediate Government Bonds are represented by the Ibbotson Associates U.S. Intermediate Government Total Return Index from the Stocks, Bonds, Bills, and Inflation data. The index measures the performance of a single issue of outstanding US Treasury note with a maturity term of around 5.5 years.
Cash & Cash Alternatives is represented by the returns of the 1-month Treasury Bill.
60/40 Diversified Mix is represented by a combination of 10.5% U.S. Large Growth Stocks, 10.5% U.S. Large Value Stocks, 15% U.S. Small Value Stocks, 4.5% International Large Growth Stocks, 4.5% International Large Value Stocks, 9% International Small Value Stocks, 6% Emerging Markets Stocks, and 40% U.S. Intermediate Government Bonds.
The 5-Year return numbers reflect the five-year annualized return of each asset class.
All returns include the reinvestment of dividends. Foreign securities involve additional risks, including foreign currency changes, political risks, foreign taxes, and different methods of accounting and financial reporting. Fixed income investments are subject to interest rate and credit risk. Emerging markets involve additional risks, including, but not limited to, currency fluctuation, political instability, foreign taxes, and different methods of accounting and financial reporting. Real estate securities funds are subject to changes in economic conditions, credit risk and interest rate fluctuations.
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