Investments for the Long Run

A common tool used by financial advisors is something called the Callan Periodic Table of Investment Returns. As you can see from the following chart, the rank order of different asset classes (color coded; top is highest performers, lowest is worst returns), is generally random.

See for yourself whether you can discern any pattern. The chart shows, better than words, that we really cannot predict whether international stocks will outperform domestic large cap or small cap stocks in any given year, or whether any of them will outperform various bond investments during the next 12 months. This explains why professionals recommend diversified portfolios. They simply don’t know, from one year to the next, which is going to perform better than what.

But the interesting thing is that if you look out over longer time periods, the returns are not quite as random. In fact, Stephen Huxley, a professor of business analytics at the University of San Francisco, found that over rolling 30-year periods, small cap stocks and value stocks consistently finished with the highest returns.

While the below chart is a little difficult to read, real estate investment trusts consistently fell in the middle of the pack, and bond investments alternated places at the bottom of the long-term return chart.

What does that mean? The consistency of this simple chart is solid evidence of something that is talked about but never actually proven — that over longer time spans returns become more consistent and predictable than they are during shorter intervals. And certain asset classes consistently, if unpredictably, seem to provide more upside potential than others.

Does that mean we should throw away the idea of diversification? Of course not. But it might suggest that, if you have a long enough time horizon, you have a decent chance of earning higher returns if you overweight certain categories of stocks, and underweight bonds. You should still hold both and rebalance each year, which increases the chances of a smoother investment ride while you wait for the asset returns to sort themselves out over time.