Stocks versus bonds and the absurdity of static benchmarking

Stop the presses. For the 20-year period ended July 31, stocks outperformed bonds by an annualized margin of 0.77%. Unfortunately, this was not headline news.

However, when, at the conclusion of the 20-year period that ended in February 2009, bonds had outperformed stocks by a margin of 0.40%, the news was impossible to miss. I know this because, for those few weeks, the phone lines in my office lit up with calls from clients who wanted to exit equities and put their entire nest eggs into bonds because they’d heard talk of a “lost decade” for stocks.

This is not a condemnation of the financial press. Without unconventional milestones, there would be no news. News is, by definition, about the extraordinary things that happen, not the ordinary. In fact, the occurrence of a negative equity premium over any 20-year period is quite rare. Since 1926 (the first year for which reliable S&P 500 data are available) there have been more than 700 rolling 20-year periods. Of those, there have only been 12 in which equity markets lagged behind bonds. Two of them occurred this year: in February and March.

The infrequency of this phenomenon, set against a backdrop of historic equity market losses in the first quarter of 2009, is great fodder for a story. It is the financial markets’ equivalent of a visit by Halley’s comet.

But while a comet comes and goes, investors’ fears are still with us, stoked by a storm of conjecture and punditry about the significance of bonds outperforming stocks. And that says a lot about the current state of the financial advisory business. The industry’s hyperactive reliance on static benchmarks to promote an agenda or make a point has backfired, creating a world in which hypothetical milestones supplant good judgment.

FLAWED BENCHMARK

The problem with any discussion of “stocks versus bonds” is that such a stark contrast between two options is an absurd premise that should never exist in the real world. Bonds/stocks is not an either/or choice. It is an oversimplified, dualistic view of finance that is reinforced by the misapplication of one-dimensional benchmarks. It is true enough that bonds outperformed stocks for the period (be it 10, or even 20 years) that coincided with the recent bottom of the equity markets. But that doesn’t mean bonds are better than stocks.

Using the same flawed 20-year benchmark that ended in February 2009 as an example, the real winner would not have been the bond investor or the stock investor, but the investor who had a portfolio, re-balanced quarterly, comprising 50% stocks (represented by the S&P 500) and 50% bonds (five-year Treasuries). That portfolio would have beaten a bond-only portfolio by 30 basis points for the 20-year period that ended in February.

So a blended portfolio must be the answer, right?

No, because it is an answer to the wrong question. By relying on oversimplified, static performance metrics, the financial services industry is perpetuating a dangerous myth that long-term asset allocation is a one-time decision based on black-and-white variables.

As the investment industry continues to evolve to meet the demands of an increasingly challenging market and increasingly sophisticated investors, we need to move away from the easy 20-year benchmarks and generic long-term market performance stats that have become the centerpieces of so many investor presentations. How an index (or a mutual fund, or an adviser) performed over the last five, 10 or 20 years is an easily accessible, easily understood piece of information, and that data point is typically viewed by most investors as an essential consideration in their investment decisions. This needs to change.

Advisers need to help investors develop personal benchmarks. The performance of the S&P 500 over any fixed time period should not be the determining factor in whether an investor can afford to retire or educate their children without going into debt.

PERSONAL BENCHMARKS

Financial professionals need to get into the business of asking questions about real-life issues: what are your goals; what are your expected payments; what is your risk tolerance; when do you plan to retire? These are real benchmarks that can be measured against and used to create portfolios that reflect real human needs, not stats that sound good in a vacuum.

Ideally, the relationship between adviser and investor isn’t measured in total return, but in first setting, and then achieving, life goals. The purpose of investing shouldn’t be viewed as earning a certain return on investment for its own sake, but to implement and follow through on a strategy designed to meet some real-world purpose.

The worker looking to retire comfortably, the retiree hoping to remain comfortable, the young couple saving for a home and the charitable foundation working to give to worthy causes in perpetuity all have unique goals.

The financial industry would do well to combine the pursuit of high returns with a new dedication to understanding what will actually best serve each investor’s personal benchmarks of success.

Gregg S. Fisher is the president and chief investment officer of Gerstein Fisher, an independent financial advisory firm.