Notes, Views, and the Occasional Provocation January / February 2015 

British wit Oscar Wilde famously wrote, "The only way to get rid of a temptation is to yield to it." What may be good advice from time to time with one's passions, however, is emphatically bad advice for one's investment portfolio.

Rather, as this month's newsletter discusses, this is the time of year when long-term investors must resist the temptation to alter course based on what happened last year. To help, they would do well to remember another noted wit Will Rogers, who observed, "The road to success is dotted with many tempting parking places."

Best regards,

Milo Benningfield

Resisting Temptation
Multi-asset-class investing has proven to be one of the surest routes to long-term investment success. So why isn't everybody doing it? more

Resisting Temptation
New Year's resolutions are about resisting temptation – the temptation to eat too much, sit on the couch, do too little work. For investors, January's temptation comes in the form of a question. After the 2008 global stock-market crash, the question was, Why hold stocks? As if on cue, the answer was delivered over the next several years as stocks soared, eventually rising past their pre-crash watermarks.

This time last year the question became, Why hold bonds? Financial writers browbeat investors with calls to action:

The search for bond alternatives is urgent. Interest rates almost certainly will rise this year as the Federal Reserve continues scaling back its massive stimulus program—and bond prices fall as interest rates rise. Even if you intend to hold your bonds until they mature, their current yields are so low that you are virtually guaranteed to lose ground to inflation.1

In fact, interest rates fell in 2014 and bond prices rose, to just about everyone's surprise, with the Barclays Aggregate Bond Index returning 5.8%. Investors who succumbed to the siren call of "bond substitutes" were left licking their wounds.

The question this year necessarily acknowledges that both stocks and bonds deserve a place in diversified portfolios, but asks whether some stocks are more deserving than others – specifically, Why hold international stocks?

Since no one seems to question asset classes that did well recently, you can guess what happened to U.S. investors with international stocks last year. Large companies in Europe and Asia fell, on average, 6%, and emerging-market stocks continued their slide, falling another 2%. Meanwhile, the S&P 500 Index, driven by large U.S. growth companies, returned 13.7%.

The trouble with international companies was not their operations, however. Despite well-publicized concerns about potential deflation in Asia and Europe, the performance of foreign companies was generally strong. Rather, the trouble for U.S. investors with international stocks was currency fluctuations.

In 2014, the U.S. dollar appreciated more than 10% against almost every major foreign currency. This meant that when earnings on international stocks were translated back into U.S. dollars, they bought fewer dollars than before, eroding the returns for U.S. investors.

The chart below shows the dramatic difference in 2014 between the investment returns of non-U.S. companies in local currencies versus their returns in U.S. dollars.

Local-Currency vs. U.S. Dollar Stock Returns
Region / Country Index Local Currency Return % U.S. Dollar Return %
U.S. (S&P 500)
Pacific ex-Japan
Emerging Markets
Source: Standard & Poor's, MSCI; all return values are MSCI Gross Index (official).

Last year, for example, Japanese stocks returned almost 10% on the Japanese stock market. But when the Yen-denominated earnings were translated back into U.S. dollars, the Japanese shares returned negative 3.7% for U.S. investors. Emerging-market stocks returned 5.6% in their local currencies, but negative 1.8% for U.S. investors.

Currency fluctuations cut both ways and boost international-stock returns when the U.S. dollar lags other currencies. After the Euro began to circulate in 2002, the dollar began a multi-year slide against it into the summer of 2008, boosting international-stock returns for U.S. investors. From 2002 through 2009, the S&P 500 Index earned 1.6% while the MSCI EAFE Index earned 7.5%. U.S. investors who allocated a third of their stock holdings to international companies more than doubled the annualized return that the S&P 500 Index offered over that period.

We don't know where currencies will move next – a point underscored last week by the Swiss Central Bank's surprise announcement that it would stop supporting the Swiss Franc against the Euro. All we really know is that the surprises will continue to happen, which is why we diversify our investments.

At base, all three questions above – why hold stocks / bonds / international stocks? – pose the same question: Do I really need to hold last year's underperformers? If you have no underperforming asset classes, it probably means you're not diversified, which means you're likely more subject to certain economic downturns than diversified investors.

However, diversified investors face their own risks each year as they have to persuade themselves once more to stay the course with their disciplined investment strategies while friends and neighbors get the bragging rights on more concentrated bets. Even positive investment returns will be disappointing when they are less positive than someone else's – a truth captured succinctly by social critic H.L. Mencken, who quipped that "a wealthy man is one who earns more than his brother-in-law."

The temptation to judge our own progress by comparing ourselves to others is, of course, human nature, as I'm reminded every time one of my sons scrutinizes the size of the ice cream scoop being doled out to his brother.

To help myself resist the distraction of unhelpful comparisons and stay on course, I like to remember the example of a childhood hero, "Bullet Bob" Hayes, a former Dallas Cowboys wide receiver. Before he revolutionized football's passing game with his lightning speed, Hayes was an Olympic gold-medalist sprinter. Asked once about his running abilities, Hayes said, ''It doesn't matter who I'm running against. It's only between me and the finish line.''

For individual investors, the finish line should be just as concrete, with financial goals defined in terms of timeframes and dollar amounts, not abstract aspirations to "make more" or "do better than the next guy." Investors who cultivate this point of view, looking neither right nor left and resisting the temptation to alter their portfolio allocations based on last year's ebbs and flows are far more likely to reach their long-term goals.

Thank you for reading. Please look for our next newsletter in March.

Best regards,

Milo Benningfield

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1 "Looking for Alternatives to Bonds," Wall Street Journal, January 10, 2014.

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