Client Letter – Q3 2017

During the past quarter, the best performing asset classes were—once again—international large value, international small, and international small value stocks. This has been a very strong year for stocks, especially international and emerging markets stocks!  The following chart shows the 3-month, 1-year, and 5-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, 2017

DFA Fund / Index3 Month Return1 Year Return5 Year Return*
S&P 500 Index4.4818.6114.22
DFA U.S. Large Value4.6120.2615.23
DFA U.S. Small5.4219.7714.48
DFA U.S. Small Value5.9719.6213.67
DFA Real Estate (REITs)1.060.249.57
DFA Int’l Large5.6519.458.08
DFA Int’l Large Value8.3025.688.46
DFA International Small6.9821.9612.15
DFA Int’l Small Value7.6025.3713.61
DFA Emerging Markets Core6.5420.324.63
DFA 5-Year Global Bonds0.550.401.64
DFA Inflation Protected Bonds0.86-1.01-0.09

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

Patience is a cardinal virtue when investing, especially when you are using a diversified portfolio that spreads your money around the globe. You were rewarded for sticking to your asset allocations over the last few years and not making major changes due to short-term fluctuations in some of your investments.

The theory of diversified investing suggests that in any specific time period some of your investments might be up, some may be down, and some may have not moved much at all. Those investments that go up will drag the portfolio higher over time. That’s because the losses on the investments that go down are limited—you can’t go down more than 100%. But investment gains are unlimited—any investment potentially can go up much more than 100%. A 100% gain would merely double your money; yet there are plenty of investments that have tripled or quadrupled an investor’s original stake. The theory also says that we cannot predict in advance which investments will grow and which will fall. Rather than pick and choose and risk a big loss, it is better to own all of them. That way you are more likely to own the winning investments that pull up your portfolio’s value.

Our portfolios were tested in 2014, when the U.S. dollar soared in value compared to other world currencies. That reduced the value of overseas stocks and hurt three of the core holdings in our portfolios: large and small stocks of developed countries outside the United States, and stocks of emerging markets countries in South America, Asia, and Eastern Europe. In a year when large U.S. stocks were up by 13.6% (as measured by the DFA US Large Company fund), you may have wondered why we continued to hold stocks in international and emerging markets, which lost money that year. And our answer was the same as always: wait a while and watch things shift while you enjoy the good performance in U.S. stocks.

And shift they did: so far this year international stocks have been contributing strongly to our overall portfolio performance. While big U.S. stocks are up by 13.6% (similar to their gains back in 2014), international small cap value stocks are up by nearly 22%, large stocks by more than 18%, and emerging market value stocks by over 20%. Meanwhile, another long-time profitable holding—small U.S. stocks—lags this year to date, offering low single-digit returns. And so it goes with a diversified portfolio: something will always be up and helping the portfolio in any given time period. Since we cannot predict which one that will be, we hold them all, and enjoy seeing our investments grow over the years.

And speaking of failed predictions, we’ve been hearing for over two years that the bond market would get crushed due to rising interest rates. Those predictions failed to foresee that inflation has remained stubbornly low, even as the economy has grown. That has allowed the Federal Reserve to slow down the typical rate increase cycle to a crawl. As a consequence, the bond market continues to offer low but positive returns. Remember that we hold bonds not for growth but for stability—we want a source of income and some portfolio value protection during times when the stock market plunges.

Thank you again for your business and your trust. This past quarter has been our best on record!

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.

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