Client Letter – Q3 2014

The third quarter of 2014 was a tale of two markets—large U.S. stocks and everything else. A handful of big stocks pushed up the Standard & Poor’s 500 Index by about 1 percent over the late summer and early fall. Meanwhile, just about every other asset class that we invest in declined, from small U.S. stocks to real estate and global bonds. The chart below shows the 3-month, 1-year, and 10-year performance of many DFA funds (representing different asset classes) compared to the S&P 500 Index:

Market Returns for the period ending September 30, 2014

 DFA Fund / Index 3 Month Return 1 Year Return 10 Year Return*
S&P 500 Index1.1319.738.11
DFA U.S. Large Value-0.1520.399.05
DFA U.S. Small-6.855.939.40
DFA U.S. Small Value-7.238.348.74
DFA Real Estate (REITs)-3.2813.108.22
DFA Int’l Large-6.074.656.56
DFA Int’l Large Value-6.514.296.84
DFA International Small-8.474.418.73
DFA Int’l Small Value-8.536.679.34
DFA Emerging Markets-3.424.8210.96
DFA 5-Year Global Bonds-0.091.803.54
DFA Intermediate Gov’t Bonds0.052.604.63

*Note: Returns for periods greater than 1 year are annualized.  Top 3 returns are in bold.

Our diversification strategy was both a curse and a blessing over the last three months: a curse because we experienced a modest decline since June; a blessing because that decline was less than some of the sharp drops we experienced in a number of our asset classes. For instance, while large domestic stocks edged up in the last three months, small stocks fell by about 7 percent. Small international stocks declined by an even greater 8 percent, while stocks in emerging markets and real estate were down about 3 percent. On a more positive note, 1-year returns remained exceptionally strong for large domestic stocks and REITs. The top performers over 10 years continue to be emerging markets and small stocks (both U.S. and international).

Are poor quarterly returns an indication that our investments are “bad” and should be sold? Of course not! Many of these asset classes have beaten the S&P 500 Index since the bear market of 2008. Using them in our portfolios has enhanced returns while reducing overall risk. We expect bad months, quarters, and even years in any and all of them. In the long run, we expect them to help us reach our goal of increasing the value of our portfolios faster than the rate of inflation.

The risks that affected stocks and bonds in the third quarter—unrest in Hong Kong, the Middle East, and the Ukraine, along with the threat of rising interest rates, a stronger dollar, and an economic slowdown in Europe and China—will continue to affect markets through the rest of the year. However, the factors that contributed to market gains this year—including a recovering U.S. economy, rising corporate profits, and an accommodative Federal Reserve Board—will also be influential. We don’t know which side will prevail or whether we will end up with a negative or positive year. In the long run we remain optimistic, no matter what happens with the markets in the short term.

Recent stock and bond market activity tells us very little about the future. We haven’t yet found a system that allows us to predict market movements with enough precision to enable us to game the markets by moving money around. The best investment research seems to indicate that no one else has discovered a reliable trading system either. We find it is better to hold on to a diversified portfolio that is regularly rebalanced to maintain its risk level.

Instead of obsessing over your portfolio we think you should concentrate on the financial decisions over which you have control, such as when and how to start taking a Social Security benefit. This important decision can cost you tens of thousands of dollars if you make a mistake. We utilize various tools to analyze your Social Security claiming choices in order to identify your optimal claiming strategy. Please call us so that we can help you make the best choice, and ask your loved ones and acquaintances to do the same.

Enjoy your fall!

Chris signature

About Christopher Jones

Christopher Jones is the Founder and President of Sparrow Wealth Management, a fee-only financial planning and investment management firm. Before entering the investment field, Chris was a management consultant for Deloitte Monitor. He graduated summa cum laude from Brigham Young University with a B.S. in Economics and a minor in Business Management.