The SP Index is Not a Strategy

Dear Clients and Friends,

If you were alive at the turn of the 20th century, you would have likely assumed that Samuel Langley was going to be the first to ‘conquer the air’, and create the first plane. Langley signed his contract with the US Department of War and was given the myriad resources of the US government to create a “flying machine”. He was certain the key to flying was “power”. However, we know that this was not the case, and the Wright brothers, working in their bicycle shop in Dayton Ohio cracked the code. They solved the equation by focusing less on power and more on balance. As bicycle enthusiasts and amateur physicists, they understood balance, so their efforts focused more on creating balance over power. As investors, we can learn a lot from this story; but what I want to focus on in this piece is the investor’s need for balance over their desire for power.

An index well-respected in the investment world is the S&P 500, which is essentially the largest 500 companies in the US market packaged as an investment vehicle. The financial industry is obsessed with the performance of the S&P because in most cases the money management industry is judged on their relative performance to this index. The S&P often represents the ideal for returns for all money management (a powerful index when it comes to returns). We can view the investment in the S&P 500 as the “power” of market investments – However, as we have seen with the ‘Langley vs. Wright Brothers’, power is not always the metric to aspire to. Most investors may be better off striking balance over the long term. To be concise on this point, S&P may be the power, but to create a portfolio that can fly, we believe one should pursue balance.

To help elucidate this point we need to look at the way power can help pursue one’s goals and the ways it can’t. From December of 1999 through December of 2009, the S&P produced a negative annual return for investors*, a detail that is rarely mentioned by the financial press.  This period is often called “the lost decade”, but had the S&P been created in the early 20th century (the index found its genesis in 1974) we likely would have had a number of “lost decades” over the last 100 years.  What may surprise you about this ’99-’09 period is the outstanding results created in the decade prior. Had you started investing in the S&P in 1989 and ended in 1999, you would have achieved a spectacular 18%* a year in returns. This type of return can undoubtedly help one pursue their goals, but the ensuing decade would have literally destroyed the capital of a person who was taking income from their investments. Herein lies the principle of balance over power: we believe that the S&P provides the power to pursue returns, but only when mixed with the balance that other investments can offer – this is the guiding principle of diversification.

So why am I focusing on this subject, given the strong market performance this year? The answer is simple: our market over the last 10 years produced a very strong return for the S&P 500. Because of the cyclical nature of our markets, we have to wonder whether the next 10-year period will be as strong (or potentially much weaker) than the preceding 10 years. If the investor wants power without balance, they will likely choose to pile in greater amounts into the investment that has beneficial return numbers. Yet, market history informs us that this strategy of power-over-balance can lead to positive results followed by disastrous losses. We have to remember that the market rises and drops, like the Wright Brothers and their flying machine, choosing balance over power may be the long-term strategy for your financial goals.



The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All investing involves risks including loss of principal. No strategy assures success or protects against losses.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

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