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How Do It Know?

The investment portfolio won’t keep hot things hot or cold things cold forever.

By James P. Ruth, CFP

The old story, bad grammar and all, goes like this: On a bitterly cold day, two homeless men were sitting on a park bench sharing a smoke and a cup of coffee from a thermos bottle. One fellow says, “You know, it must be a miracle.” “Why,” says his friend? “Well,” he responds, “If you pour in hot things, it keeps them hot and if you pour in cold things, it keeps them cold.” Then he muses, “How do it know?”

Selecting the right investment portfolio for clients can often raise a similar question. Should an advisor just pour hot investments into a client’s portfolio and hope that they stay hot? Likewise, should you pour a cold investment, one that is under performing expectations, out of your portfolio or keep it with the hope that it regains its heat? How do it know? Remember, the thermos won’t keep hot things hot or cold things cold forever, only for a period of time.

The correct answer is that no one knows for sure. The chart, Performance of Certain Asset Classes, might shed some light though. It illustrates the leading asset class for a particular year in each of the last 26 years. It shows that no single asset class has consistently dominated the others over time. Eight times, nearly one third of the time, small company stocks have out performed the other asset classes. Bonds and cash have been the leaders 27 percent of the time, out-performing large U.S. company stocks. But, would you exclude large company stocks because they only performed best 19 percent of the time?

I am not aware of any advisor who would recommend only one particular asset class to the exclusion of all the others. Remember, there are only two things an advisor can control in a mutual fund: the fund’s internal expenses and its risk relative to its peer group. I believe most advisors would recommend a mix of various asset classes to help balance risk and return because they don’t know this year which asset class will dominate next year. And obviously, past results are no indication of future performance.

Advisors can only control the temperature of an investment when it is poured into a portfolio including risk and expenses. But, like the thermos, the investment portfolio won’t keep hot things hot or cold things cold forever.

James P. Ruth, CFP, is a registered representative and president of Potomac Financial Group, a financial advisory practice in Gaithersburg, Md. He can be reached at 301-948-3900 or pfgroup@erols.com.


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