IFA Index Portfolio 100 vs. the S&P 500 Index

Thursday, January 8, 2015 12,464 views

There is no arguing the fact that compared to an undiversified U.S. large company index like the S&P 500, 2014 was a difficult year for globally diversified portfolios tilted towards small, value, international and emerging market stock indexes. The table below shows the difference between IFA Index Portfolio 100 and the S&P 500 Index for 2014 and several other periods of time. 

The chart below explains why we designed Index Portfolio 100 to have a tilt toward small, value, international and emerging markets.

Below is a summary of the 2014 returns for the diversified IFA Index Portfolios on the left and the individual component indexes on the right. As you look down the column of index returns, you can quickly see the wide divergence in returns for 2014. To view this table for alternative periods, click here. Below this table we will break down the differences and explain how diversification benefits investors over time. 

IFA does not consider the S&P 500 to be a proper benchmark for the full range of IFA Index Portfolios. Index Portfolio 100 would be the closest with a correlation of about 0.9 to the S&P 500 over the last 87 years. But even when correlations are high, there are periods of wide divergence such as we saw in 2014.  Some investors think that real estate is where they should have a high concentration of their money and for them 2014 meant a 19.4% outperformance of Index Portfolio 100. However, to look at the 10.4% difference of the S&P 500 vs Index Portfolio 100, here is how it breaks down.

  1. The asset class with the highest return in 2014 was global real estate which had a 22.74% return. It contributed to a reduction in the difference between Index Portfolio 100 and the S&P 500 Index.
  2. U.S. small cap and small value stock indexes returned 4.44% and 2.94% respectively and contributed almost half of the difference.
  3. U.S. large cap value stocks returned 10.07%, thus accounting for a small portion of the difference.
  4. International equity indexes of large value, small cap and small value were all negative at -6.99%, -6.30% and -4.99% respectively, which accounted for about a third of the difference.
  5. Emerging market equities indexes of large, value and small cap delivered -1.71%, -4.41% and 3% respectively, but due to a relatively small allocation, they accounted for a small amount of the difference.
  6. When IFA quotes whole index portfolio data, IFA deducts the highest fee charged to any client of 0.90%, while no advisory fee is assumed for the S&P 500 Index. This fee also contributed to the difference. However, IFA fees should not be considered an expense without a value added and due to a tiered fee schedule, client's fees will vary. According an IFA study, clients who followed IFA's advice captured 93.2% of index portfolio returns, while those who did not follow IFA's advice only captured 56.8% of the index portfolio returns. So, it is unlikely the investors without a passive advisor would have captured either the S&P 500 return or the Index Portfolio 100 return. 

Please keep in mind that investing in equities in general, but more specifically globally diversifying and tilting towards the risk factors of small cap, value and direct profitability is only for well-advised, educated, and long term investors. As seen in the chart below, we expect to see many years when risk is not rewarded with positive returns. This is  what risk is! If future returns were certain, the seller would embed those certain returns in the price, positioning the buyer to have no expected return. Risk is the source and the economic reason for return, and a higher exposure to compensated risk will engender a higher expected return. Remember that the S&P 500 has been outperformed by bonds in 30% of 12-month rolling periods over the last 87 years.

As the bar chart below shows, for the 87 years from 1928 to 2014, Index Portfolio 100 has outperformed the S&P 500 Index in 48 (or 55.2%) of them. Since this year was about a 10% difference, we looked at how often that occurred. Index Portfolio 100 beat the S&P 500 Index by 10% or more in 20 years (23.0% of the years), and the S&P 500 beat Index Portfolio 100 by 10% in 11 years (12.6% of the years).

Gary Belsky and Thomas Gilovich wrote Why Smart People Make Big Money Mistakes and reminded their readers that "odds are you don't know what the odds are." To better understand the odds of Index Portfolio 100 beating the S&P 500, you need a chart like the one below. It shows the percentage of the time that one investment beat the other in different holding periods.  As you can see, in 12-month rolling periods, Index Portfolio 100 beat the S&P 500 60.27% of the periods, but in 20-year monthly rolling periods, it was 86.98% of the time. The larger the sample of time, the more the odds improved that Index Portfolio 100 was the highest return investment. 

(Click for a more interactive flash chart)

In the shuffle of annual returns, we should not lose sight of the goal of maximizing ending wealth. As the chart below shows, while Index Portfolio 100 and the S&P 500 Index had similar volatility over the last 50 years, the growth of $1 was over 3.6 times greater with Index Portfolio 100.

(Click for a more interactive flash chart)

Lastly, for those investors who are tempted to believe that they can pick next year’s winning asset class, we remind them that there is simply no feasible way to accomplish that, as indicated in the chart below. As you can see, there has been a constant shuffling of asset class returns each year. If Flash is running on your computer, you can click any asset class to isolate it over the 20 year period. Above the chart, however, we have placed a table showing the 20-year annualized returns of the nine asset classes showing that U.S. small cap value delivered the highest return for the entire 20-year period. 

step 11portfolio construction2014risk-calibrated portfolios