Net Worth & Investment Results

by J. David Lewis – 

There is more to money than money®Investment performance is only one of many factors that influence growing financial strength.  Even during the best market conditions, the far more significant influences for improving wealth are investment contributions, withdrawal management and debt management.  No investment return can produce meaningful progress without these disciplines.  This has been particularly true since 2000.  Yet, we know people who have surprisingly good financial growth through these years.   In How Financial Advisers Get Clients to Take Action –, a Wall Street Journal article highlighted Resource Advisory Services’ unique methods for helping clients with this sort of thing.  I wrote about tools you can use yourself to manage these factors in “A ‘One Task a Year’ New Year Resolution”.   I will now discuss a couple of our investment performance observations that appear to be at play recently.    

We describe our use of actively managed mutual funds on our website in Investment Philosophy.  We believe carefully selecting these managers can produce returns that exceed the expenses within the mutual funds.  They “fine tune” the asset allocations for us.  Our rebalancing is generally less overt than it would be with indexed mutual funds.  By this, we mean a large part of our rebalancing is accomplished by having mutual funds pay cash distributions instead of reinvesting.  We can then make conscious reinvesting decisions.  This year, Bryan Hankla and I have been discussing a subtle and interesting asset allocation phenomenon that has been developing for a good while.   

The mutual fund data service, Morningstar, attempts to classify mutual funds according to many traits – probably too many to be useful.  Two of the major divisions are the growth investment style versus the value investment style.  In reality, each of these styles is defined by philosophies and methodologies of investment managers.  Growth investing is about finding companies that have grown in the past, with a high probability they will continue that growth.  Value investing is about finding companies that have underlying value greater than the current stock price reflects.  One would be hard pressed to prove either method is better than the other over the long term.  In the short term, one or the other often prevails.  There are outstanding experts using each style.  Very few are able to effectively shift from one style to the other.  So, we like to keep a balance of mutual funds committed to each style.   

Instead of attempting to quantify these abstract approaches, Morningstar attempts to consider some companies growth and some value using mathematical techniques.  Then, they deduce the growth or value mutual fund management style by the preponderance of these styles in mutual funds.  It is not at all uncommon to hear investment managers adamantly object to the style Morningstar has assigned it.  We follow the “corporate personalities” of mutual funds we use enough to judge whether we believe these objections are well founded.  They usually are. 

For at least a year, we have noticed that Morningstar has been reclassifying a number of mutual funds from value to growth.  Have these mutual fund managers changed their management disciplines?  Have companies Morningstar once considered value companies become growth companies?  Should we sell and buy mutual funds to restore our allocations between growth and value based only on Morningstar assignments?     

I have not forgotten a couple of dinners with Chuck Royce, in the 1980s, when his mutual fund offering was much smaller than now.  He talked about the importance of developing a style and methodology that you can believe strongly enough to stick with it through thick and thin.  For him, it was small cap value.  More than twenty years later, his firm seems to have never drifted from that approach, although it has been severely out of favor at times.  Other managers we follow appear equally committed to their unique styles of management.  If we believe one changes its philosophy, we are more skeptical than we are after a year or two of weak performance relative to the general market.   

So, when we see that Morningstar has moved a mutual fund from one category to another, we pay more attention to whether the manager is still approaching its job the way we expect than the label given by Morningstar.  To be sure, we pay attention to the Morningstar categories.  We also pay attention to other sources of information about our choices.  A dose of judgment is important.  We want to know as much as we can about the mutual fund managers’ investment styles and let those professionals do the job our clients’ pay for in mutual fund fees.  This is a reason Bryan has visited a few mutual fund companies in recent years, to see how committed they are to their styles. 

There is another interesting asset allocation observation we have not heard discussed.  It is the difference between performances for U.S stocks versus international stocks.  At the end of October, the twelve-month return for the S&P 500 Index was +8.09%.  The comparable return for Vanguard Total International Index Fund was -6.54%.  This helped us understand how much impact our international mutual funds were having on total portfolio returns.  By January 31, 2012, the disparity of 14.63 percentage-points had widened for a couple of months and then narrowed slightly to 13.20 percentage-points.  It was 4.22% for the S&P versus -8.98% for international stocks as of January 31, 2012.  How should we feel about our allocations to international stocks? 

There is substantial market history that speaks for long term international investing.  We continue to believe it is important to maintain appropriate international allocations.  Since January 31, 2002, the S&P 500 Index return was 3.52%.  This compares to 7.11% for the Vanguard Total International Index Fund – roughly double the S&P return.  Other evidence clearly indicates one-year performance is a very poor predictor that a category, like international stocks, will continue the same trend through the next year’s performance.  So, we continue to believe we should maintain international allocations essentially as we have in the past. 

My years of experience with this sort of thing have convinced me that Chuck Royce was and is right on the matter of maintaining discipline.  To the extent investment performance has influence on net worth, our tendency to use international, mid-cap and small-cap funds in larger percentages than the S&P has helped our clients’ net worth over the longer-term.   

Contact J. David Lewis directly with or share your thoughts on this topic below. He founded Resource Advisory Services in 1985.  National Association of Personal Financial Advisors (NAPFA) was formed only a few years before. Lewis became a NAPFA-Registered Financial Advisor in 1986.  He is a passionate advocate for fiduciary, fee-only financial planning and has been associated with financial services since childhood in a banking family. 57427