By Joseph Matthews
As a boy playing Little League in the 1970s, I started every baseball season believing my Red Sox would be World Series champions. My optimism and hope were unbridled in spite of my favorite team”™s often lackluster roster.
Those decades leading up to the last 10 years and three world championships were often frustrating. Yet, in spite of not fielding winning teams, the Red Sox taught me about tenacity. Although those early seasons could have ended better, I believed the Red Sox organization always had its fans”™ best interests in mind as it attempted to field the best team each year. It reinforced the reasons why I loved baseball.
The fortitude of dedicated Boston fans is a good characteristic for investors, too.
As investors, we may find the construction of our portfolio frustrating. The cause of this frustration frequently lies in the investor asking the question, “Why didn”™t I have more money invested in ”¦?” Unfortunately, this question is often asked after a certain investment has significantly outperformed an investor”™s portfolio. For those investors who have built their portfolios using an optimization process ”” a process that creates a well-diversified portfolio expected to generate the lowest amount of risk for a given level of expected return ”” they will most certainly be able to identify investments that have done better than their portfolio in the recent past.
A portfolio should be consistent with an investor”™s tolerance for risk, investment time horizon and need to draw money from the account. Because of this process of optimization ”” and the management of risk that accompanies it ”” most of these types of well-diversified portfolios may have a somewhat lower performance than individual asset classes in bull markets.
As we look at the U.S. markets through the first ten months of 2013, many things stand out. The taxable U.S. bond market, as measured by the Barclays Capital Aggregate Bond Index, is down just above 1 percent through October. The Barclays Municipal Index, measuring tax free bonds, is down more than 2 percent year to date through October. These returns may be a shock to bond investors as many have become accustomed to outsized returns during the three-plus decade bull market. Bond investors have experienced negative calendar year returns in only two other years, 1994 and 1999, certainly upping their frustration.
In contrast, U.S. stocks are having a banner year. Many indices have generated 20 percent-plus returns year-to-date. However, based on mutual fund inflow/outflow information, many investors still appear to be underweight in stocks in their portfolio. The experience of large negative stock returns in 2008 seems to haunt many.
As frustrating as investing in stocks can be, not being invested in stocks can be even more frustrating.
An investor in the Standard & Poor”™s 500 stock market index during the 20 years ending December 31, 2012, would have experienced an annual return of 8.14 percent, leading a hypothetical initial investment of $100,000 growing to $478,360. Investors who missed just the 30 best days in that same 20 year time period saw their portfolio generate a negative 0.16 percent annual return, causing the same $100,000 to shrink to $98,280. Of course, an investor cannot invest directly in a market index. The investor who had the fortitude to stick with his or her portfolio through many difficult markets and seemingly catastrophic events was rewarded handsomely for his or her patience. The investor who lost focus and tried to time the market put him or herself at risk of not achieving his/her goals.
Woe to the investor who manages his portfolio the way Boston managed its early trades.
Boston won five world championships by 1918. However, this was followed by one of the longest championship droughts in baseball history, dubbed the “Curse of the Bambino.”
Harry Frazee, early owner of the Red Sox, made what many considered to be notably poor trades: Duffy Lewis, Leonard and Ernie Shore were traded to the Yankees.
Later, Frazee sold Wally Schang, Waite Hoyt, Harry Harper and Mike McNally were traded to the Yankees. The following winter, shortstop Everett Scott, and pitchers Bullet Joe Bush and Sad Sam Jones were also traded to the Yankees, followed by Joe Dugan and Elmer Smith. Then came the trade of Herb Pennock to the Yankees.
The loss of so much talent sent the Red Sox into free fall.
Imagine how Frazee could have fared had he held onto his best assets.
Joseph Matthews is branch manager, first vice president, financial adviser and senior investment management consultant, Global Wealth Management Division of Morgan Stanley Wealth Management, Fairfield; (203) 319-5165 or Joseph.Matthews@morganstanley.com.
