In a world where almost every market report mentions the performance of the S&P 500, it might be wise to consider just how well this measure has performed over time and what role it should play in a portfolio. The numbers suggest that despite some spectacular short-term results, too many investors put too much of their money in large-cap stocks.

Investors tend to treat large-cap U.S. stocks as a basic portfolio building block. But large-cap U.S. stocks have not been one of the more stable portfolio ingredients in recent years.

Admittedly, large-cap U.S. stocks were extraordinary in 2013: SPDR S&P 500 (SPY), an ETF that tracks the benchmark large-cap index, produced a one-year return of 32.32%.

What’s more, the three-year annualized return of U.S. large-cap stocks as of Dec. 31 was 16.08%. That was the best three-year performance of any of the 12 asset classes shown in the “Portfolio Ingredients” table on the following page. The index’s five-year annualized performance (at 17.85%) was also impressive.

The 10-year and 15-year performance figures were relatively poor, however, with the 15-year annualized return clocking in at just 4.58%.


In order to measure each asset class’s consistency, I calculated the standard deviation of these five returns (over the one-, three-, five-, 10- and 15-year periods). The standard deviation for U.S. large-cap stocks was 10.9% — nearly the highest among the 12 asset classes examined. Although this is only one approach among several to calculate stability of performance, a high standard deviation figure does reveal high variability in returns — indicative of poor consistency of performance.

The last row of the table displays the average three-year rolling return for each asset class. In the 15-year period from 1999 through the end of 2013, there are 13 three-year rolling periods. The first is from 1999-2001, the next from 2000-2002, and so on. I calculated the three-year annualized return for each of the 13 periods, and then calculated the average of the 13.

Last year’s darling, the S&P 500, had an average three-year annualized return of 3.15%. That’s the second-worst showing of all the asset classes, and not that much higher than cash, which had an average three-year return of 2.31%.

Calculating the average three-year rolling return assesses the level of performance over time. Consistency of performance is important, but so too is level of performance. Standard deviation is a direct measure of performance consistency, while average three-year rolling return is a measure of performance level.


Looking at the other asset classes, there are combinations of risk (as calculated by standard deviation of the five annualized returns) and return (average of 13 three-year rolling returns) that are much more attractive than U.S. large-cap stocks — at least over the past 15 years.

For instance, U.S. mid-cap stocks, as measured by the SPDR S&P Midcap 400 ETF (MDY), had a standard deviation of 9.7% and an average three-year return of 8.34% — a combination superior to large-caps in terms of both performance consistency and performance level.

U.S. small-cap value stocks had slightly higher standard deviation than large-caps but a considerably higher average three-year return of 9.11%.

Developed non-U.S. stocks, as measured by iShares MSCI EAFE index fund (EFA), had a lower standard deviation than U.S. large-cap stocks and a slightly higher average three-year return.

Emerging non-U.S. stocks also had a lower standard deviation of returns than U.S. large-cap stocks and an average three-year annualized return of 11.37% — more than three times higher than the S&P 500.


Perhaps surprisingly, real estate was the best overall performer among the 12 individual asset classes, with its combination of 5.2% standard deviation and 11.56% average three-year annualized return.

Commodities has an undeserved reputation as a very risky asset class. So it is intriguing to note that the standard deviation for the PowerShares DB Commodity Tracking ETF (DBC) was lower than for U.S. large stocks, while it had a dramatically higher average three-year return of 12.71% — the highest of the 12 asset classes being considered. (Note that when an ETF in this analysis did not have a 15-year performance history, I used the performance of the underlying index, minus an implied expense ratio.)

But like many other asset classes, commodities had a rough year in 2013 in comparison with U.S. large-cap stocks. As a result, for those with a short-term view, commodities may be viewed as an inferior asset class.

Natural resources (iShares North American Natural Resources, or IGE) had considerably more consistent performance than the S&P 500, with a 4.8% standard deviation versus 10.9% for the S&P 500 — and almost triple the average three-year return.

The four fixed-income asset classes, as expected, had very consistent performance, with very low standard deviation of returns.

U.S. bonds had a standard deviation of 2.9%; non-U.S. bonds, 3.1%; and cash, 1.1%. The outlier was TIPS, with a standard deviation of 6%, quite a bit higher than the other three fixed-income classes and largely the result of a loss in 2013 of 8.5%. That one negative return caused the standard deviation of TIPS to spike. But TIPS also had the highest average three-year return in the fixed-income sector, at 7.11% — more than twice that of the S&P 500.

This analysis is not aimed at denigrating the S&P 500 but rather to demonstrate that a variety of other asset classes offer impressive consistency and level of performance — and are worthy of consideration when building a portfolio.


Finally, consider the consistency of performance of a blend of all 12 asset classes.
A 12-ingredient, equally weighted model produced an average three-year annualized return of 8.15% — two and a half times higher than the S&P 500.

The standard deviation for the blended portfolio was 1.9%, lower than all but one of the 12 ingredients. Only cash had a lower standard deviation. In terms of risk and return, the 12-asset portfolio has provided compelling results over the past 15 years.

In 2013, that 12-asset model produced a return of 9.54%. This was a very solid return, but it paled in comparison to the lofty return of the S&P 500.

This type of short-term performance differential can induce investors to overly focus on a single asset class and neglect their commitment to diversification. While the U.S. large-cap stock group is an important asset class, it is only one component of a diversified portfolio.

The value of broad diversification is manifested over time, not typically in short time frames. Even a three-year period is a relatively short time in the world of meaningful portfolio performance.
This may come as a real shock to investors — and perhaps even to financial advisors — reacting to quarterly or monthly performance figures.

Consider the analogy of the oak tree: If its growth was measured after three months, the result would certainly be disappointing. Diversified portfolios are like oak trees — they represent long-term commitments.

Of course, all this implies that an investment portfolio is built according to a plan and then followed for a reasonably long period of time. Chasing the hot asset of the month (or year) is not an investment plan. Rather, it’s a recipe for unnecessary volatility and disappointment.

Craig L. Israelsen, a Financial Planning contributing writer in Springville, Utah, is an executive in residence in the personal financial planning program in the Woodbury School of Business at Utah Valley University. He is also the developer of the 7Twelve portfolio.

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