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Five Decades of Indexes: Which One Predicted the Next?

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Nobel laureate Eugene Fama was once asked at an investment conference about the value of making portfolio decisions based on a decade worth of results. His response: "Ten years is noise." 

Still, we keep getting questions from investors about whether they can glean any clues about how to make asset-allocation decisions now by looking at the past decade's winners. According to such logic, if growth-styled stocks prevailed in the past 10 years -- or large caps did better than small caps -- shouldn't we simply keep riding those same horses down the stretch?

Our own research and experience managing client portfolios over the years has led IFA to come to the same conclusion as Fama and other leading academics. From a purely evidence-based and statistical perspective, IFA's portfolio managers find that trying to design an asset-allocation plan around how different types of assets performed in the past decade just doesn't provide much more than background "noise."

To help illustrate how misleading it can be to slice benchmark results into 10-year increments, we've put together a series of graphs. Each compares risk and return numbers for a variety of IFA indexes covering different asset classes. Instead of reviewing just one or two of these periods, however, we present the past five decades. 

The 2010s

Some investors focus on the 500 biggest U.S. companies. Indeed, a blended index of large-cap domestic stocks (the IFA SP 500 Index), fared relatively well in this decade. (See figure 1.) However, benchmarks providing exposure to U.S. large-cap growth and technology stocks did even better. During the 2010s, growth-styled domestic equities might've appeared the place to be, so to speak.

Figure 1

The 2000s

IFA indexes tracking international small-cap value and emerging markets large-cap value stocks rose from relative losers in the past decade to become top performers in the 2000s. (See Figure 2 below.) Such a revival of fortunes also took place in real estate and U.S. small-cap value stocks.

Figure 2

The '90s

The tech-heavy IFA NSDQ index rose to the top during the '90s. (See Figure 3 below.) High-flying equity asset classes from the '2000s like emerging markets and domestic small-cap value wound up with trailing returns compared to the IFA SP 500 Index. 

Figure 3

The '80s

In this period, underweighting a portfolio to international value stocks would've proved a mistake. (See Figure 4 below.) And that's whether you're looking at allocations to small- or large-cap foreign equity funds.  

Figure 4

The '70s

If you started to put together a diversified and passively managed portfolio based on this 10-year period, IFA's blended index of international small-cap stocks would've seemed to be a winning bet. (See Figure 5 below.) During this decade, value-styled foreign stocks appeared less appealing of an investment.

Figure 5

To condense such findings, consider Figure 6 below. It pulls together all five divergent decades to show how a diversified index-based portfolio actually would've played out. Of note is how important global diversification proved to be after the dust settled over the entire 50-year period. Tilting to smaller company stocks and value-oriented fare also clearly wound up to be savvy portfolio decisions in terms of allocating between different indexes.    

Figure 6

So, which decade turned out to best predict expected returns? The answer is quite simple: None.

As you can see, outcomes in different parts of the markets can be highly variable when looking at what's happened in the past decade. That's true whether you're looking at asset styles or market capitalization sizes. Figure 7 (below) gives us another way to look at how random asset-class returns appear when slicing-and-dicing results over the past decades.

A case in point: The IFA International Small-Cap Value Index had a monster '80s, then fell to dead last in the '90s. Even a more staid U.S. Large Company Index has proved tough to predict -- in the 2000s, it was a cellar dweller. In the next decade, it landed at the top of the heap. 

Figure 7

The evidence provided here reinforces how detrimental trying to 'cherry pick' performance based on a past decade's results is to the asset-allocation planning process. Instead, IFA's wealth advisors strongly recommend that clients make sure to cover all of their bases by holding a broad range of investable asset classes in their portfolios. Our research shows that investors can most effectively increase their odds of capturing greater market returns by sticking to a globally diversified and passively managed asset-allocation plan over a lifetime of building wealth.

To provide more information about how investors can utilize such a five decades analysis, IFA founder and president Mark Hebner has created the video shown below. 

 


This is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, service, or considered to be tax advice. There are no guarantees investment strategies will be successful. Investing involves risks, including possible loss of principal. This is intended to be informational in nature and should not be construed as tax advice. IFA Taxes is a division of Index Fund Advisors, Inc. For more information about Index Fund Advisors, Inc., please review our brochure at https://www.adviserinfo.sec.gov/ or visit www.ifa.com.