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Did You Earn 40% This Year?


By Matt Carvalho, CFA, CFP®, Director of Investment Research, Loring Ward 

That sounds like a crazy question, right? CDs, savings accounts and many bonds are paying next to nothing. Return expectations are down across the industry. Yet, if you held U.S. small companies from their lows in February of 2016 through mid-December you would have seen a more than 40% gain on that position, as measured by the Russell 2000 index. And who saw that coming? 
 
For the last few years, U.S. large cap stocks have lead the way in performance, outperforming small companies, international and emerging markets. Coming into 2016, the common question was why even bother with a diversified portfolio when you could just buy large household names like Apple or Visa and enjoy the gains we’ve seen since 2009.
 
Yet, any look back at historical returns will show us that recent performance is not a good predictor of what will happen next. And 2016 is shaping up to be one of those
unpredictably predictable years, where following the recent trend might not have been the wise move.
 
As of 12/14/2016, large value outperformed large growth by 9% and small companies outperformed large companies by 8%.
 
Keep in mind this was following several years where many of these asset classes underperformed large growth companies. Many investors started to wonder if it was worth the wait.
 
Looking at the chart below, you can see that large companies outperformed small over the past few years. However, had you sold off your small cap exposure heading into 2016, you could have missed out on an additional 8% of returns for that portion of your portfolio.

While we believe U.S. small companies, or value or emerging markets for that matter, are an important piece of a diversified portfolio, no one can predict when performance like we’ve seen in 2016 will occur next. The decision to invest in small or large companies could look good or bad depending on the day you look at your statement. A diversified portfolio will always have some great performers and some less-than-stellar ones, but having gains occur on different asset classes at different times can help to reduce the level of ups and downs the portfolio experiences.
 
Remember, in order to capture that 40% gain from the lows in February you had to stay invested, even after that asset class dropped by 16% and the potential temptation to sell was highest. That’s often been true over time — reversal of relative returns can occur quickly in different investments, and in order to take part in those gains you have to be able to stay consistently invested in those areas for the long run.

Source: Morningstar Direct 2016, U.S. markets represented by respective Russell indexes for each category (Large: Russell 1000, Value, and Growth, Mid: Russell Mid Cap, Value and Growth, Small: Russell 2000, Value and Growth). Indexes are unmanaged baskets of securities that are not available for direct investment by investors. Index performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. 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. All investments involve risk, including the loss of principal and cannot be guaranteed against loss by a bank, custodian, or any other financial institution.