As we look at the last quarter of the year it’s a good time to talk performance. While it’s been a great year for the stock market – up double digits in 2017 – the more conservative portfolios are not keeping pace. Even though risk has been rewarded this year, our less aggressive Income Portfolio is still outperforming the S&P 500 over ten years. The reason? Ten years back includes the Great Recession and that’s the reason, for some, to be conservative.
I want to evaluate why the Income Portfolio is lagging so far behind this year, discuss some redeeming qualities of this less aggressive portfolio, and then offer a suggestion if anyone is underwhelmed with their portfolio’s return.
Why is the Income Portfolio not keeping up with the stock market?
We use fine people at Morningstar to help us invest and they had mixed results this year. The Morningstar Hare Portfolio – what we base our Growth Account on – is doing quite well, up about 20%. However, the Morningstar’s Dividend Portfolio – what we base the Income Portfolio on – hasn’t kept up with the stock market, up approximately 4%.
Returns in the stock market this year have primarily been in growth companies, not big dividend paying companies. A lot of the companies Morningstar selects for their Dividend Investor Portfolio are utilities, real estate, oil & gas, and telecom. These are typically not known for their great growth potential and are bought more frequently for their consistent dividends, which is exactly why we own them.
With interest rates heading up now, the dividend-paying companies will be paying more interest on their debt and that negatively affects profits. We knew interest rates were going to be a headwind, but we’re comfortable with the risk. We thought the consistency of the growing dividends and relative safety of the essential service industries are a great place to invest for those with a moderate risk tolerance or who use the accounts to generate income.
Should I continue to invest more conservatively than the market?
The time to evaluate a more conservative portfolio is not in the 8th year of an up market, which is where we are today. The best time to be conservative is during a downturn. Think 2001, 2008, and 2011. How close are we to the next downturn? We’re not sure.
This more conservative approach was a fantastic strategy in these ugly years, not so much in 2017. However, we can still make the case for staying in a moderate risk portfolio using the long-term graph. Let’s look at the track records of our target/model portfolios looking backwards ten years. These returns will differ from actual results and do not imply future performance:
Current Income Portfolio
(moderate risk):
1 yr return 3.6%,
3 yr return 5.15%,
10 yr return 7.75%
Current S&P 500 Returns
(aggressive risk):
1 yr return 18.6%,
3 yr return 10.8%,
10 yr return 7.44%
Current Growth Portfolio
(aggressive risk):
1 yr return 17.7%,
3 yr return 14.3%,
10 yr return 19.33%
Income Portfolio
As you can see, the 10 yr return of the Income Portfolio has kept up with the stock market while having less than 60% of the volatility of the stock market. This is because of the ugly 2008-9 markets, which hammered the stock market and left the Income Portfolio much better off. Without that time frame the Income Portfolio wouldn’t keep up.
There will be another downturn and the Income Portfolio will be the new favorite portfolio again. In order to participate more in growth years we are adding more funds. Just today we added a large position in an ETF called First Trust’s Dividend Leaders FDL because it’s had better growth. This should help increase returns in the growth years ahead.
Growth Portfolio
On the other hand, the current Growth Portfolio is doing well by beating the stock market over 10 years with same volatility as the stock market. Matthew Coffina, CFA at Morningstar, has performed really well the last four years he’s been at the helm.
Another change we made on his recent recommendation is selling Time Warner TWX. This had a nice gain for those who’ve held it for more than a year. We are replacing TWX today with toy company Hasboro Inc HAS, which is down 9% today on ToysRus bankruptcy news and is highly touted by Motley Fool, another subscription we follow.
Can I take more risk?
A suggestion we’ve been making for those that feel like they can take more risk, is to invest at least a portion of their portfolio in the more aggressive Growth Portfolio we offer. We can, of course, move the whole portfolio, but this might not be appropriate. To accomplish this, we may need to create a separate account to keep the two portfolios separate.
Doing this can help some clients smile when the market races ahead, because they’ve participated in the runup. By moving only a portion of a portfolio, clients can also smile when we inevitably get “the” pullback, because they’re still invested in the more stable Income Portfolio.
I’m sure there are more questions out there. Please don’t hesitate to contact us to talk about your specific situation.
Thanks for reading,
Bruce Porter & Tim Porter, CFP®