Charles Rotblut will speak at the 2015 AAII Investor Conference this fall; go to www.aaii.com/conference for more details.
This month’s issue contains comparative performance data that is historically infrequent and that, with the possible exception of next year, may not be repeated for a long time.
The feature article reveals the mutual funds with the highest annual returns over the past five years. But what I want to call your attention to is Table 1, Five-Year Returns for Category Averages. This table shows how each of the 39 mutual fund categories we track performed over the past five years.
Bond funds led all categories, occupying nine out of the top 10 categories. (The gold sector was the only category preventing a clean sweep by bond funds.) Falling interest rates over the past five years (January 2007 through December 2011) and the timing of the last bear market created a scenario that made bond fund returns look really good in comparison to all other categories.
A similar statistical event could occur when we move the five-year period forward to January 2008 through December 2012, but the bond categories will need some help. Global stocks would have to end the year essentially flat or down, while global bond yields would have to hold steady. Beyond next year, it could be a long time before we see bond funds dominate the five-year category rankings as they do now.
As I discuss in the article, these numbers show the importance of understanding the context in which returns are presented. There can often be external factors that influence performance. Thus, always look past a return figure and consider the driving factors behind it.
I think it is also important to view performance in terms of the decisions you will actually make during periods of high market turbulence. The more I read about behavioral finance, the more I realize that part of being a successful investor is having the ability to hedge against your own emotional tendencies.
One way of accomplishing this is to incorporate a routine strategy of rebalancing. Rebalancing shifts your portfolio back to your allocation targets, lowers your portfolio’s volatility and keeps you on track to achieve your long-term financial goals. I walk you through the process, detail the financial impact of such a strategy over the past 24 years when withdrawals are factored in, and show how a rebalanced portfolio’s allocation evolved on an annual basis starting here. (I also show you the performance impact when no withdrawals are made.)
The returns you realize are also impacted by taxes, and the tax rates for 2013 are uncertain. Among the tax laws set to change are the exemptions for the gift and estate income taxes. Peter Katt suggests that couples with large estates will be able to leave their heirs larger inheritances if they take advantage of the gift tax credit, even if the exemption is reduced next year. He shows you how, using an irrevocable life insurance trust, starting here.
The performances of our Model Mutual Fund Portfolio and Model ETF Portfolio were hurt by exposure to small-cap and value stocks last year, as AAII Founder James Cloonan explains. Both investment styles have proved superior over the long term, but can underperform over shorter periods of time. James’ latest commentary on the portfolios and the markets can be read here.
Finally, we have the second installment in a new series of articles about financial statement analysis. Joe Lan walks you through the income statement, explaining each of its primary components. He also discusses the concept of accrual accounting and explains why companies may keep one set of books for investors and another for tax authorities. It is great article that will help you better analyze how well, or poorly, a company is performing. Joe’s article begins here.
Wishing you prosperity,
Charles Rotblut, CFA
Editor, AAII Journal