1st Quarter Client Note

Stocks picked up – not quite where they left off in 2013 – with a respectable gain. Following a remarkable 32.39% gain in 2013, the S & P 500 Index increased 1.81% in the quarter; but not without a little bit of excitement and the re-emergence of volatility. The news was ever changing: Congress passed a spending bill and raised the debt ceiling. Military tensions between Russia and Ukraine came to a head. And the economic recovery plodded along, despite fears of a slowdown; which in retrospect appeared to be largely related to the persistent cold and snowy winter weather. Despite the relatively anemic level of the post Great Recession recovery, it has already lasted longer than half of all post World War II recoveries.

Other than Global Real Estate (which had an extraordinary 7.03% return) most equity asset classes trailed the S & P 500 Index. The MSCI EAFE Developed Market Index rose .66% and the Emerging Markets Index fell .80%. Commodities rebounded from their multi-year negative performance, showing a gain of 7%.

Mild Surprise in the Bond Market

New Federal Reserve Chair, Janet Yellen, was sworn in on February 3 and announced some policy changes signaling, perhaps, an early taper to the Fed’s expansionary monetary policy. Ironically, the yield on the benchmark 10 – year Treasury responded by falling from 3.0% in January to 2.7% in March. Consequently, bond prices rallied and the Barclays US Aggregate Index gained 1.84% – even as fixed income market pundits continued to position for rising rates.

Coping With Market Volatility

While we expect diversified portfolios of stocks and bonds to increase in value over an investing lifetime, history and experience demonstrate that this doesn’t occur in a straight line. And given the five-year run up in the stock market it makes sense to be prepared for more volatility. Indeed, there were 11 swings of 1% or more during this March alone.

Asset allocation and diversification among riskier asset classes (with higher return expectations) combined with less risky ones (for controlling volatility) are the main portfolio management tools. Ideally – although no one has the perfect portfolio – you will have just the right mix to give you a reasonably good chance of achieving your goals and also allowing you to sleep at night. A few other useful ideas contribute to the effort:

  • Have a game plan as a way to inoculate yourself from making the kinds of hasty decisions that kill investors.
  • Maintain an Investment Policy Statement (IPS) including sustainable saving and spending policies.
  • Maintain ample liquidity in cash and short term bonds to meet short and intermediate term spending needs.
  • There are times, of course, in which changes to your plan are advisable or even necessary. These should be few and far between and you should anticipate these well in advance so you can make these changes incrementally.

Warren Buffet is quoted extensively in this quarter’s Quarterly Market Review from Dimensional Funds Advisors, which we try to pass along every quarter. One of Mr. Buffet’s great observations for managing volatility is contained in his 2014 letter to Berkshire Hathaway shareholders, advising investors to take the same attitude toward stocks as they do toward real estate. “Those people who can sit quietly for decades when they own a farm or apartment house too often become frenetic when they are exposed to a stream of stock quotations. For these investors, liquidity is transformed from the unqualified benefit it should be to a curse.” Good advice from the octogenarian.

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