Time to remind clients why they won’t beat the Dow this year

As 2017 marches into history, most investors will agree: It was a pretty darn good year. But your clients might need to be reminded why they didn’t beat the Standard & Poor’s 500 stock index.

As of Wednesday, the S&P 500 had clocked a 22.2% gain, including reinvested dividends. While not a record — 2009 and 2013 were better — there’s no doubt that stock investors should be celebrating. With the exception of bear-market funds and energy funds, all Morningstar equity categories showed a gain.

The problem for advisers: Balanced portfolios likely shaved points off your clients’ returns. For example, funds that allocated 50% to 70% to stocks — a classic balanced portfolio — gained 13.2%. That’s better than the average return for the S&P 500 for the past seven decades, but still not as good as this year’s S&P 500.

“Just a few years ago, people were scared and wanted to have more cash and bonds,” said Scott Bishop, executive vice president and partner at STA Wealth Management. “Those same clients want to know why their balanced portfolio is not outpacing the Dow in 2017! That is why at least once a year I meet with clients to review the financial plan to help see that they are on track.”

The 2007-2009 bear market still casts a long shadow across many investors’ memories, and that helps a bit, said Dan Wiener, co-founder of Adviser Investments.

“We hear it less now since even nine years later the memory of 2008 is still there, plus our allocations to foreign stocks have finally helped, rather than hindered, performance,” he said Nevertheless, he said, after so many years of up markets, investors seem to forget what their original objectives and risk tolerances were.

“It’s all about setting expectations,” said Robert DeHollander, managing principal of DeHollander & Janse Financial Group. “As advisers, clients make their biggest mistakes at the tops and bottoms of market: Our jobs are to navigate those more so than anything else.”

One tool he finds helpful is a software program called Riskalyze. “We can say, ‘Here’s what the S&P 500 did in 2013 and in 2008, and here’s what your portfolio would have done in that year,’” Mr. DeHollander said. The illustration shows clients why they might want to give up some upside for downside protection.

Mr. Wiener worries that investors who switched to index funds might not realize that those funds will offer little protection in a bear market.

“After the 2008 debacle, lots of folks felt their active managers didn’t make good on their promise that active would hold up better in a downturn, so they moved to index. Well, now I think most have probably forgotten that they chose to simply buy the market. When the next downturn comes, we think there’ll be a reconsideration of some note as index funds fall along with the market.”

As for 2017, large-cap growth funds were the best diversified performers for the year, jumping an average 28.1%, according to Morningstar Inc. And, while small-company U.S. stock funds trailed their larger brethren, small/mid-cap foreign growth stocks leaped 35.2%, edging out diversified emerging markets funds (32.7%) and foreign large growth (30.4%).

The fund industry was loaded with quirky funds and ETFs with enormous gains, such Bitcoin Investment Trust (GBTC), up a mind-melting 1,501.6%, and ProFunds UltraChina (UGPIX), up 106.4%. Yet even the 10 largest diversified U.S. stock funds racked up respectable gains, averaging a 23.0% return on the $2.1 trillion they manage.