It’s that time again! Clients are unhappy because they haven’t kept up with the S&P 500 - as if that was actually a financial goal that was important. Beating any particular index is pretty much irrelevant to achieving a successful retirement. 

Here’s a thought experiment for you: 

Save $1 annually and bet it all on the S&P 500 over the 30 years or so that is the typical savings period for the typical American. Okay, so $1 annually for about 30 years at 9.5% is going to give you around $100 for your retirement; but hey, you kept up with the S&P 500, and that’s what’s important right?

No. You have to save enough, keep your costs low, and stay diversified if you want to maximize the chances of having a successful retirement.

It’s usually in the last few years of a bull market that clients start to chafe at the relatively tame returns of their low-cost, diversified portfolios. We lost clients in 1998 – 2000, and again in 2006 – 2007 - they just couldn’t stand not swinging for the fences. I’m guessing most (all?) of them regretted their decision in short order. And again, we’ve had a few clients bolt for advisors who are telling them that it’s a wonderful time to increase their exposure to stocks. They say, “We’re in the early innings of a new secular bull market! Sky is the limit!”

Maybe, but probably not. 

The valuation metrics we use point toward a zero return for the S&P 500 over the next 12 years or so from current levels. Unfortunately, they don’t tell us anything about how those returns will be achieved – one bad bear market? Two? A 12-year flatline? 

We don’t know. But we do know, with a fairly high degree of certainty, that we’ll see 2,000 on the S&P 500 again at some point during the next bear market, or close enough. Hardly a bold call given that the record high is only 2,941, and the typical bear market loses more than 30%, which would take us to right around 2,000. The last two bear markets were 50% plus affairs, which would take us all the way to 1,470 or so. There is a non-negligible possibility that the S&P 500 might be right back to where it was in the year 2000 before the next bear market is over. Even a return to only 2,000 by year 2020 would mean a whopping 33% gain, excluding dividends for the S&P 500 over a 20-year period. That’s an annualized return of only 1.67%.

Throw in the dividend and you’re still only at about 3.67% for that 20-year period. How do you think those investors who bet it all on the S&P 500 will be feeling then? Not hard to imagine that at least some of them, perhaps many of them, will have had to re-enter the work force due to a failing retirement. Could that perhaps be a contributing factor as to why more and more people are working past 65-years of age?

Einstein famously said “God does not play dice with the universe.” Well, we don’t believe investors should play dice with their retirements. Investing in properly diversified, low-cost portfolios with the right mix of assets for your retirement (spending) plan will greatly increase your chances of having a successful retirement, but that means trailing a single, volatile asset class like the S&P 500 during a U.S. bull market. It’s going to happen. It’s inevitable. The payoff is when you’re substantially outperforming the single, volatile asset class during a bear market. And that brings us to a critical detail of the whole diversification strategy: You must judge the strategy based on the entire cycle from peak to peak, or trough to trough. Of course, the diversification strategy is going to look bad during the tail end of a bull market in the U.S. stock market, just as a diversification strategy is going to look like a real winner at the bottom of a bear market. The success of diversification must be measured for the entire cycle, not just half the cycle.

As it happens, this year has been particularly brutal for diversified portfolios because the scope of negative returns in the various global financial indexes has been unusually broad. According to the November 30th issue of Barron’s Magazine, Deutsche Bank said 89% of the global financial indexes it tracks were negative in dollar terms through the end of October. Barron’s goes on to write that the average is 29% of financial markets finishing with losses in any given year.

What should diversified investors do? Stay the course! “At the tail end of what is now the longest equity bull market in history, this is not the time to worry about the drag imposed by diversifying asset classes,” says Rob Arnott, co-manager of Pimco All Asset All Authority fund.

Even if you decide a diversified portfolio isn’t for you, now is not the time to change. Rather, make the change to a concentrated, bet the ranch strategy after the stock market is down 30%, 40%, 50%. It’s the best time to concentrate for the next bull market ride. Of course, most investors won’t because, hey, diversification just looks so good at the bottom of a bear market!