The wisdom of Dr. Seuss is far reaching. One of his tales that is particularly relevant as we enter 2014 is The Bippolo Seed. In this story, a duck finds a special seed that can grant wishes. Before the duck gets the seed planted, he is distracted by a fox advising him to wish for far more than he was originally seeking. The seed gets lost and the opportunity vanishes with it. The dangers of greed highlighted in the rhyming text will guide us this year.
While everyone wants exceptional returns from their investments annually, it is important to set realistic expectations. We must remember that we cannot control the returns of the various investment markets. What we can control is how much exposure we have to different investment markets and which funds we use to provide the exposure to the markets.
Coming off of 2013, a year which delivered 30% returns in the stock markets, we need to set appropriate expectations for 2014. The bull current market has driven the S&P 500 index up over 170% since the market low set on March 9, 2009. The long-term average return of the stock market is between 9% and 10%. Given that the recent returns have been far above the long-term average, we should expect that 2014 will deliver less robust returns and likely single-digit returns for the stock market.
The bond markets face the same headwinds in 2014 that they faced in 2013. It is expected that we will experience rising interest rates and rising inflation in 2014 and in the years to come. These two factors negatively impact the prices of bonds. Moreover, it will be difficult for bonds to deliver positive returns as the Federal Reserve decreases the amount of stimulus it provides to the economy. Despite the negative outlook for bonds, they continue to play an important role in portfolios both as a defensive holding and as a source of income generation. We expect bonds to have modest returns of between zero and 5% this year. In an effort to increase the likelihood of clients’ bond investments achieving positive returns, we have taken steps to diversify bond exposure in client portfolios to minimize the impact of rising interest rates and rising inflation.
We intend to maintain the strategies that have worked well for us in prior years as we believe these strategies are particularly well suited to more challenging investment environments. These strategies include overweighting the value style of investing and underweighting the growth style of investing. This is consistent with the approach we took in 2013. While last year the growth style indexes outperformed the value style indexes,our equity performance in most all client portfolios exceeded the broad market benchmark indexes. This was due in part to the superior investment performance of the Dimensional Funds that we use heavily in client portfolios. In 2014, we expect that the value style will be more in favor and our emphasis on that style should deliver positive returns.
Another portfolio strategy we have implemented involves capturing the returns related to stock market volatility. Volatility tends to negatively impact stock returns. The Ironclad Fund, which is used in client portfolios to capture these volatility returns, earned over 10% last year in a low volatility environment. The early results suggest that stock markets may be more volatile in 2014 making the Ironclad Fund that much more important as a component in client portfolios. We are proud to report that we are among the earliest investors in the Ironclad Fund. Our clients have benefited from our knowledge about the portfolio manager and his investment performance prior to opening the fund. For the three-year period ending December 31, 2013, of the 7,885 mutual funds in the Morningstar database, no fund had a higher annualized total return with less risk than Ironclad! The fund has exceeded our expectations.
Looking ahead, the global economy continues to show signs of growth despite the lingering existence of significant debt challenges in the U.S. and many other countries. The complementary investments used in client portfolios should be more valuable in 2014 than they have been in prior years as the traditional asset classes are likely to underperform their long-term average returns. We will continue to stay globally diversified without overweighting any asset class or style of investing too heavily. Keeping Dr. Seuss’ teachings about greed in mind, and remembering that wealth management is a marathon and not a sprint, we will look to make the most of the opportunities that present themselves but will not take excessive risks in an attempt to repeat last year’s results.
This update is intended for the use of Oak Wealth Advisors LLC clients. This update should not be viewed as personalized investment or financial planning advice from Oak Wealth Advisors LLC. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to their individual situation, they are encouraged to consult Oak Wealth Advisors LLC. Past performance does not guarantee future results and all investments should be scrutinized before being implemented in a portfolio.