Have you ever wondered how different asset classes have performed from year to year? And more importantly, what are the ways that you could benefit from that knowledge?
The Callan Periodic Table of Investment Returns gives you exactly that information. But also baked into this chart are valuable lessons that can help make you a smarter investor in these three ways.
1. Diversification will help you win
You hear that you should diversify your investments, but doing so comes with a trade-off. Buying the best-performing asset class could mean great returns. If you owned real estate investments in 2006, you would've seen your accounts grow by 42% in one single year.
But this type of upside comes with the same kind of downside risk, and in 2008, you could've lost 48% of your account value if you only owned this investment. That's why diversification is so important: Adding other asset classes like large-cap stocks or bonds can help even out your returns. In the following table, you can see how your returns are impacted when you diversify.
|Asset Mix||2006||2008 (Decline)|
|Real Estate (100%)||42.12%||(48.21%)|
|Real Estate/Large-Cap Stocks (50/50 mix)||29%||(42.6%)|
|Real estate/Large-Cap Stocks/Bonds (34/33/34 mix)||20.74%||(26.65%)|
2. No asset class wins forever
There are some asset classes that over the long run have higher average annual rates of return than others. For example, over the long term, large-cap stocks have an average annual rate of return of about 10%, and bonds have an average annual rate of return of 6%. But that higher average annual return usually comes with increased volatility and is not a guarantee that it will always land on top.
Instead, each type of investment has its role in your portfolio. In bear markets, safer investments like bonds should outperform riskier holding like stocks. And during bull markets, stocks should do better than bonds. Like in 2008 when all stock-related asset classes had double-digit losses, cash and bond categories had a positive performance.
If something you own doesn't do well in a year, this doesn't mean that it isn't a good investment. And it's also possible that if you get into a habit of dropping investments that haven't done well, you might find yourself chasing returns.
For example, small-cap stocks lost 11% of their value in 2018 but had more than a 25% gain the following year. And in 2017, emerging market equities performed the best, gaining 37% -- but only after having lost 15% two years before and being the worst performers. So selling these investments because of a year of losses would've caused you to miss out on subsequent years with gains.
3. Rebalancing can set you up for success
Not only should you avoid selling investments because they're not always winners, but you should also consider buying more of your losers. When you rebalance your portfolio, you are selling your holdings that did very well and buying ones that didn't do as well.
When a security or asset class is winning, your natural instinct may be to buy more of it. But a better move for you might be to sell some of it because your mix of stocks and bonds might be out of whack as a result. So if you start off the year with an asset allocation model that consists of 50% stocks and 50% bonds, and stocks do really well -- causing their allocation to go up to 60% of your portfolio and your bonds to drop to 40% -- you might have a riskier investment mix than you want.
Selling your bonds and buying more stock because it's performing well will only give you a higher stock percentage. If the stock market continues doing well, so will your accounts, but if it crashes, you could lose more money than you bargained for.
In a year like 2008, you would've lost 15% of your account value if you had a portfolio with a 50/50 stock/bond mix. But if you had 70% stock and 30% bonds, you would've lost 24%. Rebalancing your portfolio can help you stay allocated in a way that lines up with your risk tolerance.
Investing might seem complicated. And the more confusing it is, the more intimidating it might be. But it doesn't have to be, and you don't need to be an expert to succeed. Learning a few key lessons can go a long way in helping you reach your goals.