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Just before we close the door firmly shut on 2013, I thought it would be informative to make a quick review of the returns we saw over the last year in the major asset classes and see how holders of a typical portfolio may have fared. (We'll get to the 59% shortly). This is a follow-up article to a similar review of 2012 which was published twelve months ago, and I've included some of the data from that article so that we can compare 2013 with 2012.

For the purpose of this article, I have taken again the following eight asset classes as representative of the typical asset classes a mainstream dollar-orientated investor may have included in a portfolio. The table shows the overall return for each of the asset classes for the year with the corresponding volatility, as well as last year's figures for comparison.

Asset Class

Return / %

Volatility / %

Return / %

Volatility / %

2013

2012

S&P 500

29.6

8.6

13.4

10.6

DAX

24.2

11.3

29.1

14.8

MSCI EM

-5.0

11.9

15.2

19.9

Gold

-28.2

18.5

7.3

16.0

Cash

0.5

0.1

0.1

0.0

US Gov

-1.9

2.9

2.1

2.1

US Credit

-0.2

3.3

7.8

2.3

US High Yield

5.9

5.3

13.8

4.8

It is easy to see how 2013 was a much more challenging year than the previous one. Other than the stand-out performance of the S&P 500, every single non-cash asset class underperformed compared to its performance in 2012, with the most significant underperformer being (as is well known by now) Gold.

Here are the results depicted on a standard return-volatility graph:

Return and Volatility of Selected Asset Classes, 2013

So before moving on, let's spend a brief second kicking ourselves for not holding 100% of our investments in the DAX for the last two years, as the clear outperformer over the last 24 months. (I'm sure I read somewhere headlines about Europe imploding, the euro breaking up and massive unemployment in the European periphery).

Again, similar to the point I made last year, the ability to forecast individual asset class returns over the short-to-medium term is fiendishly difficult. And as we all know from our portfolio-theory basics, diversification theory was set out by King Solomon in Ecclesiastes around three thousand years ago (if you're not sure about that, look at last year's article for the proof). More recently, Markowitz added a few equations and got a Nobel Prize. But the simple, 3000 year-old advice is to diversify. And as King Solomon suggested, we could start by simply splitting our investment equally between the eight asset classes.

If at the beginning of 2013 we would have equally split our investments between the eight asset classes - in 2013 the outcome would have been a rather paltry performance of 2.1% with a volatility of just under 6.0%. This compares to 2012's similar equally-weighted diversification strategy, which would have seen a rather impressive return of just over 11% with a respectable volatility of 7.3%.

The results are shown in the table below.

Return / %

Volatility / %

Return / %

Volatility / %

2013

2012

2.1

5.7

11.0

7.3

2013 certainly didn't present a mouth-watering set of returns, but nonetheless a simple diversification strategy would have worked to prevent any significant portfolio losses along with a reasonable level of volatility.

So how about that 59%?

Well, if your investment advisor had perfect foresight (don't they all?), he or she would have rotated all your investments into the number one performing asset of the coming month, at the beginning of each month. The investment classes you would have chosen are shown in the table below, and would have resulted in a very nice return of 59%.

Top performing asset class on a monthly basis

Month

Top Performing Asset Class

Jan

S&P 500

Feb

S&P 500

Mar

S&P 500

Apr

US High Yield

May

DAX

Jun

Cash

Jul

Gold

Aug

Gold

Sep

MSCI EM

Oct

DAX

Nov

DAX

Dec

S&P 500

I thought it was interesting to note the "variety" of the top performing asset class each month, though not surprisingly, the best performing asset class was dominated by developed world equities in seven of the twelve months. But the difficulty of market timing is aptly illustrated - even cash made an appearance as an outperforming asset one month. And given the headlines about gold last year, who would have thought that it also managed to be the top performing asset for two consecutive months in the middle of the year?

But before you go and vent your frustrations at your investment advisor for not spotting the obvious winning asset class every month - (even more so if your investment advisor is yourself), you can console yourself with knowing what would have happened if your market timing had been so terrible that you picked the worst performing asset class on a monthly basis.

In that case, you would have been finishing the year with a hefty loss of 40.3% - not pretty. It would have come about if you had picked the assets in the table below, on a monthly basis. (No surprises about which asset dominates the table - in fact gold hogged the limelight and was either the best or worst performing asset class in eleven out of the twelve months in 2013)

Worst performing asset class on a monthly basis

Month

Worst Performing Asset Class

Jan

Gold

Feb

Gold

Mar

MSCI EM

Apr

Gold

May

Gold

Jun

Gold

Jul

Cash

Aug

S&P 500

Sep

Gold

Oct

Gold

Nov

Gold

Dec

Gold

Again, this is obviously a light-hearted look at what 2013 delivered in the world of investing. But it does make a serious point about the benefits of diversification, and the difficulty in accurately predicting outperforming asset classes over a short time period.

So, however your portfolio performed, I don't apologize for quoting again the words of the great Warren Buffett:

"I know people who have a lot of money and they get testimonial dinners and they get hospital wings named after them. But the truth is that nobody in the world loves them. If you get to my age in life and nobody thinks well of you, I don't care how big your bank account is, your life is a disaster."

So, with that - here's wishing you a great 2014!

Source: What?! You Didn't Get A 59% Return On Your Investments Last Year?!