Best Choice Software stood out among all the advisers bragging about their eye-popping returns at the Las Vegas Money Show held in May.
In a promotional video, the Bradenton, Fla.-based firm boasted about a user of its trading software who “turned $1,000 trades into over a quarter of a million dollars in less than a year” — which could be equivalent to an annualized return of 25,000% or more.
Sunny Decker, the company’s founder, said in an interview that returns of this magnitude are not necessarily the typical experience of his firm’s clients.
I was a speaker at the Las Vegas event, and perhaps it isn’t any wonder I found few people who were genuinely interested in the returns that I said were realistically attainable over the long term: about 10% to 12% a year.
Even that could be considered generous. Since Jan. 1, 1929, the S&P 500 has risen at a 9.4% annualized rate, according to data from Ibbotson Associates, assuming dividends were reinvested. Riskier small-cap stocks are the lone group to creep into double-digit territory, with an 11.9% annualized return since 1929.
Of course, these returns reflect the performance of large baskets of stocks, and it is possible that you can do significantly better by picking individual companies or timing moves into and out of the market.
But the odds of that are poor. Researchers have consistently found that the bulk of advisers who try to beat the market end up lagging behind over the long term, and the select few who are able to do so rarely beat an index fund by more than a few percentage points a year.
Consider the 200 services tracked by the Hulbert Financial Digest over the past 20 years. The model portfolio with the best return — the “Average Risk” portfolio from the Investment Reporter, edited by Marc Johnson — has beaten the dividend-adjusted S&P 500 by 6.6 percentage points a year. That is impressive, but a far cry from the big numbers many investors think are readily attainable.
It is a similar story with mutual funds. According to Lipper, the domestic stock fund with the best 20-year return, the T. Rowe Price Media & Telecommunications Fund
beat the S&P 500 by 6.1 percentage points a year. (The fund charges annual expenses of 0.80%, or $80 per $10,000 invested.)
Even Warren Buffett, widely considered to be the most successful long-term investor alive, has beaten the dividend-adjusted S&P 500 by a mere 9.9 percentage points a year since 1965. It is worth noting that Buffett, at the recent annual meeting of his company, Berkshire Hathaway
warned that his future returns won’t be as good as in the past.
And don’t forget: These impressive returns are among the best that most individual investors can expect; the typical adviser did far worse. The median newsletter portfolio trailed the S&P 500 by 1.3 percentage points a year, and the median domestic stock fund lagged behind by 0.3 point a year.
To be sure, returns much greater than these aren’t unheard of over shorter periods. But invariably, they come back to earth. When confronted with an adviser promising huge returns, you therefore can confidently bet that his advertising either is outright misleading or reflects performance over such a short period as to be unsustainable.
Your proper response in either case is the same: Ignore him.
Since the vast majority of stock-market advisers trail the return of the market itself, the safest bet for the domestic stock portion of your portfolio is an index fund benchmarked to the broad stock market. One of the cheapest is the Schwab Total Stock Market Index Fund
with a 0.09% expense ratio.
What about other asset classes besides U.S. stocks? Unfortunately, those for which Ibbotson has data back to 1929 have performed no better. Long-term U.S. Treasurys have produced a 5.5% annualized return, while long-term corporate bonds have done only slightly better, at 6%.
An exchange traded fund that is benchmarked to a basket of U.S. investment-grade bonds, including both Treasurys and corporate bonds, is iShares Core Total U.S. Bond Market
with a 0.08% expense ratio.
Commodities data doesn’t extend back to 1929. But Geert Rouwenhorst, a professor of corporate finance at the Yale School of Management, has constructed an index back to 1959 that reflects the average performance of all publicly traded commodity futures contracts. Since then, he said in an interview, the index’s total return has been very similar to that of the U.S. stock market.
This index exhibited little correlation with the U.S. stock market, however, so commodities still can play a valuable role as a portfolio diversifier. One ETF that is benchmarked to this index is the United States Commodity Index Fund
with a 0.99% expense ratio. (Rouwenhorst is a partner at SummerHaven Investment Management, which is an adviser to this ETF.)
Data for non-U.S. stock mutual funds also doesn’t extend back to 1929. But, according to Lipper, the median international stock fund in their database has lagged behind the median domestic stock fund over the past 20 years by two percentage points a year, on an annualized basis.
Like commodities, international equities also exhibit relatively low correlations with U.S. stocks. One low-cost index fund that is benchmarked to stock markets outside the U.S., investing in both developed and emerging countries, is the Vanguard Total International Stock Index Fund
with a 0.22% expense ratio.
Mark Salzinger — editor of the No-Load Fund Investor newsletter, whose asset-allocation advice has produced one of the best 20-year track records in the Hulbert Financial Digest rankings — recommends that investors put 50% into domestic large-cap stocks, 10% into domestic small-cap stocks and 10% into international stocks. He recommends putting the rest in investment-grade U.S. bonds.
What about commodities? Salzinger currently recommends avoiding them. But he says that an allocation of up to 20% — while reducing your stock holdings accordingly — makes sense if you believe we are entering “a terrifying period of high inflation.”
Mark Hulbert is editor of the Hulbert Financial Digest, which is owned by MarketWatch/Dow Jones. Email: firstname.lastname@example.org
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