2013 Year in Review (Part 1)

“Perseverance is not a long race; it is many short races one after another.” – Walter Elliott

These are my investment lessons and takeaways from an interesting year in 2013.

1. Forecasting the Short Term is Hard (same as it ever was). Raise your hand if you predicted that U.S. stock markets would rise by more than 30% last year. Anyone? No takers?

I definitely didn’t see these kinds of returns coming, but I know that they have happened in the past so I’m not shocked.

Forecasting short term market moves means figuring out what the collective moves of both rational and irrational investors will be. Some can do this. Most can’t.

Markets never really cooperate or act as we expect them to.  There are no average returns in the stock market.  This will continue to be the case.

2. Bonds Can Lose Money. When interest rates rise, bond prices fall. For longer maturity bonds, prices can fall a lot. Long term treasuries (TLT) lost over -13% in 2013. Emerging market bonds (EMB) were down almost -8%.

The total U.S. bond market (AGG) didn’t fair that bad, losing around -2%, but bond investors have become conditioned to expect only positive returns year in and year out. And why shouldn’t they? Since 1976, there were only two down years in the Barclays Aggregate Bond Index before 2013.

Bond investors have to go back before the 1980s to see a time when bonds actually lost money on a consistent basis. Ten year treasuries lost money in real, after inflation terms in the 1950s, 1960s and 1970s.

I’m not calling for that environment again, but it wouldn’t surprise me.

Since bond price volatility is magnified at lower rates, investors were scared out of bonds once losses occurred in the spring of this year. Bonds don’t have anything near the volatility you get in stock prices, but you will see much higher volatility in bond prices at 2-3% interest rates than at 5-6% rates.

Possibly the best fixed income move that investors could make right now would be to harvest some of their stock gains and use that money for spending needs. This works for rebalancing purposes and takes away the need to worry about chasing yield or interest rate risk in bonds.

3. Commodities Make for Volatile Investments. I’m still not sold on commodities as an asset class, but Wall Street has been pushing this theme on investors since there was such a large run up in commodities in the 2000s.

We’ll see if that’s still the case after 2013. The commodity complex as a whole didn’t do that bad as DBC was down -7% or so. But some notable commodities did take it on the chin. Gold (GLD) was down almost -30% and silver (SLV) was off over -36%.

This is a hated asset class right now, so it will be interesting to see if commodities make for a contrarian investment play in 2014.

4. Diversification Means You’re Bound to Hate Some of Your Investments. Investors that had their portfolios exclusively in U.S. stocks should be quite happy with their 2013 year end performance review.

Consider yourself lucky if this was the case. It’s nearly impossible to pick which asset class or region of the world will be the top performer on an annual basis. This is why it makes sense to spread your bets and stay diversified.

Investors in some markets outside of U.S. stocks didn’t fare nearly as well. Besides the relative underperformance in bonds, emerging market stocks were the notable laggard this year. EM stocks (VWO) dropped almost -5% in 2013.

5. Tilting Over Timing. I hope investors realize that it never makes sense try to play the all-in or all-out game with their investments. You’ll never win this game on a consistent basis. You are much better off choosing an asset allocation that fits your risk profile and time horizon and then figuring out how to stick to your plan and control your behavior.

It’s perfectly fine to tilt your portfolio (5-10%) to over or under weight an asset class or investment if your research tells you that it makes sense (and good luck to you in this endeavor).

But it’s not OK to try to time the market. Countless times I was asked by readers, friends and co-workers what to do now that they had sold out of all of their stocks because of the fear of a crash only to see the market continue to move higher.

Just because the market has crashed in the recent past doesn’t mean it has to do it again after regaining those losses. It certainly can crash, but it doesn’t have to. large scale timing moves are best left to the professionals and I haven’t found too many of them that are very good at going all in or all out yet either.

I continue to believe the best way to take advantage of the movements in the various markets is to have a systematic rebalancing policy.  Your timing will never be perfect but the process works over long time frames.

6. The Fear Trade is Over. The permabears have spent the last 5 years hoping for a bizarro world where the Fed didn’t step in and save the financial system from near collapse. They scared many investors out for the markets because they wanted the system to be reset just so they could be proven right.

These purveyors of doom and gloom have been telling you that the economy was going to crash and a depression was on the way. The advice was to buy gold to prepare for hyperinflation and another huge crash.

Thankfully, this ideology has been taken behind the woodshed to some degree. We had one of the worst recessions in a generation and things aren’t perfect, but the system didn’t collapse.

This was a good strategy for page views and sound bites on CNBC but it appears as though this was just a slow economic recovery brought on by a huge bubble in debt. These things eventually happen over long business cycles.

Markets will continue to fall because that’s what they do sometimes but that’s not a signal that the world is coming to an end.

Optimism should still be your default frame of mind.

7. Long Term Investing Still Works. A simple 60/40 portfolio made up of the Vanguard Total Stock Market and Total Bond Market index funds has annual returns of 12.9% over 5 years and 6.6% over 10 years.

There were many bumps along the way to get there, but that’s how risky assets work.

If you are able to trade in and out of the market while chasing the best performing investments and funds and do better than those performance numbers then more power to you.

But you have to ask yourself if putting in all of the research and activity are worth your time. This type of hyperactive investment strategy requires threading the needle with the obligation of higher costs and more stress.

The long term route requires less time, effort, stress and costs out of your pocket.

Check back tomorrow for part 2 where I give some of my favorite reads from the past year along with my awards for sports, movies, TV and music.

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