This has unquestionably been a strong year for the stock market, with the S&P 500 (SNPINDEX: ^GSPC ) having posted gains of more than 26%, even before accounting for the impact of dividends that its components have paid throughout the year. But millions of investors are complaining that they haven't done nearly as well with their portfolios. Why have ordinary investors had so much difficulty matching the market's gains? Let's look at three big reasons.
1. Diversification across asset classes has cost investors a lot in 2013.
Investors learn early on that to reduce their risk of suffering big losses, spreading their money into assets other than stocks can help give them a smoother ride. Unfortunately, the effect of that smoother ride during strong years for stocks is to dampen returns, with the expectation that a diversified strategy will produce more modest losses in down years for stocks.
This year, diversification has been outright deadly. Consider:
- Investing in bonds has been costly, with the Vanguard Total Bond Market (NYSEMKT: BND ) posting total-return losses of 2%. Long-term bond funds have gotten hit even harder.
- Commodities have gotten crushed, with SPDR Gold (NYSEMKT: GLD ) losing a quarter of its value this year. Broader measures of commodities haven't done as badly, with rising energy prices playing a key role in keeping losses in the S&P GSCI commodity index limited to just 2% for the year. But commodities generally haven't provided the price support they have in past years.
- Real estate investment trusts have also suffered, especially at the higher end of the dividend spectrum. Broad REIT benchmarks were up low single-digit percentages for the year, but many mortgage REITs have plunged on fears of higher interest rates.
Add these factors together, and it's easy to see how other holdings have weighed on your overall results. That doesn't mean diversification is dumb, but it does mean you can't expect to enjoy extremely good returns when stocks outperform.
2. Own foreign stocks? You're probably behind.
With the U.S. stock market soaring, foreign markets have had a tough time keeping up. A strong dollar has weighed on the value of investors' foreign holdings as well, making their dollar-based returns even weaker. In general, markets in developed-economy countries have fared well, with the iShares MSCI EAFE ETF (NYSEMKT: EFA ) climbing 17% so far this year. But emerging-markets countries have gotten hit much harder, on fears that Fed tightening could pull money out of their markets. The Vanguard FTSE Emerging Markets ETF (NYSEMKT: VWO ) is down 7% on the year.
3. Not taking enough risk.
One surefire way to miss out on the market's return has been not to be aggressive enough with your portfolio. For retirees and other conservative investors, having substantial assets set aside in cash and other safer investments makes a lot of sense, and they have to expect to underperform the stock market in good years.
But for many younger investors, steering clear of stocks has really been costly this year. Even amid calls that stocks are overpriced, for those with 30, 40, or even 50 years left before they'll need to tap their investments for living expenses, accepting returns of just a fraction of a percent makes little or no sense.
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