The High Anxiety of All-Time Highs

Treat record high stock prices with neither excitement nor alarm.

KEY TAKEAWAYS

  • Financial journalists stoke investor “record-high” anxiety by implying in articles that physical laws apply to financial markets—what goes up must come down.
  • But shares are not heavy objects kept aloft through strenuous effort. They are intangible perpetual claims on firms’ future earnings and dividends.
  • If stocks have a positive expected return, continually reaching record highs even for extended periods are outcomes we would expect to see at times.

Investors prone to much media news watching are frequently conflicted when record high stock prices are reached. They are excited about the increased values of equity holdings but apprehensive that new higher prices could foreshadow a pending downturn and losses. Adding to their fear, the media’s “buy low, sell high” mantra may cause a reluctance to make new equity purchases as planned, keeping those funds “safe” in cash or Treasuries. That becomes a recipe for portfolio underperformance.

Financial journalists contribute to investors’ record-high anxiety by articles with analogies implying that the laws of physics apply to intangible financial markets—in other words, that what goes up must come down. “Stocks Head Back to Earth,” read a Wall Street Journal headline back in 2012.1 “Weird Science: Wall Street Repeals Law of Gravity,” Barron’s put it in 2017.2 And a Los Angeles Times reporter had a similar take last year, noting that low interest rates have “helped stock and bond markets defy gravity.”3

Those alarmed by such commentary will either shy away from systematic stock purchases as record highs continue, or worse, panic and begin selling at any sign of a market decline. But shares are not heavy objects kept aloft through strenuous management effort. They are perpetual claims on those companies’ future earnings and dividends. Thousands of business managers daily seek out projects they believe offer profitable returns on capital that provide goods and services they believe people will desire. Although many new ideas and businesses end in failure, years of history in the U.S. and elsewhere offers abundant evidence that people can be rewarded by supplying capital for a broadly diversified set of firms through intermediaries like Dimensional and Professional Financial.

Whether selling at a new high or a new low, today’s share price reflects investors’ collective judgment of all the knowledge out there about what tomorrow’s earnings and dividends are likely to be for firms in the financial markets—and what is expected from all their future tomorrows. Every day, every hour, stock prices adjust to deliver a positive expected return for buyers. Otherwise, trading will not take place. A scenario where prospective buyers voluntarily invest and expect to lose money at the same time is difficult to imagine.

Financial markets through the mechanism of trading impartially evaluates what is collectively known about future prospects and profitability of those firms traded. The market turns that information into share prices. For most investors who don’t understand the nature of “market efficiency,” getting a lesson from the Market for those with a contrary belief are rewarded only with an expensive education.

Experienced professionals treat record high prices with indifference, with neither excitement nor alarm. If stocks are priced by the markets to provide a positive expected return, a series of record highs even for an extended period is an expected outcome. Using U.S. historic month-end data over the 94-year period ending in 2020, S&P 500 Index simulations produced new wealth highs during more than 30% of those monthly observations. Moreover, systematically purchasing a broad stock index during extended periods with all-time market highs has, on average, generated similar returns to a strategy purchasing stocks only following a sharp decline. See Exhibit 1 over 1-, 3- and 5-year periods. Why does this happen?

Exhibit 1: Average annualized returns for S&P 500 Index after-market highs and declines

Chart of Exhibit 1:Average annualized returns for S&P 500 Index after-market highs and declines

Past performance is no guarantee of future results. For illustrative purposes only. Index is not available for direct investment. Performance does not reflect the expenses associated with the management of an actual portfolio. S&P data © 2021 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved.

Human minds are conditioned to extrapolate from recent past events in terms of physical movement. Too often an unconscious thought process leads to believing that after a strong rise in stocks or a stock, a fall must inevitably come. Fearing potential losses, investors are tempted to fiddle with their portfolios in order to lock in their gains (while also holding onto losers too long, hoping vainly to show an eventual profit). But timing signals exist only in investor imaginations. Efforts to improve results by futile timing usually penalize outcomes and create unwanted stress.

Be reassured, contrary to standard story lines, increasing share prices do not “fight” forces of gravity. Instead, record highs alone that we have seen over the past year, in the absence of other information, inform us only that markets are working just as we would expect—nothing more.

Using Headlines for Investing?

At some future day we cannot predict, U.S. stock market prices will stop rising and begin to decline dramatically. Valuations relative to stock prices, especially in the U.S., are at historic record highs such as before the Tech Bust in the late 1990s, as we wrote about in Planning Perspectives. An informed investment strategy will not make bets on the continued rise of growth stocks versus value stocks, or the rise of U.S. stocks versus those of other countries. Instead, a globally diversified portfolio with a balanced equity/fixed income allocation appropriate to your risk capacity and preferences can position most investors to profitably “dollar-cost average” during the accumulation phase of planning.

Somewhere some economist is being asked by some media commentator why now is or is not a time to invest. Most economists give predictions only because they were asked. Habitually reacting to media headlines leads to headaches at best and reduced returns at worst. Too much attention to your portfolio almost inevitably leads to pain and not gain.

Being uninvested to reduce or avoid paper “losses” for even a few wrong days can dramatically offset many years of positive returns, studies show. For marital harmony, it’s better to have a CFP professional to blame for what may appear to be—in the short-run—a disappointment. And while more than occasionally you may be disappointed with your statements, with the right advisors you can be pleasantly surprised with the long-term progress of a truly informed investment strategy and well-executed management process.

Rather than spend time and effort to guess when to invest or be invested, know what you can control and determine to stick with a professionally planned wealth planning strategy.

1Jonathan Cheng and Christian Berthelsen, “Stocks Head Back to Earth,” Wall Street Journal, February 11, 2012.

2Kopin Tan, “Weird Science: Wall Street Repeals Law of Gravity,” Barron’s, August 7, 2017.

3Russ Mitchell, “Tesla’s Insane Stock Price Makes Sense in a Market Gone Mad,” Los Angeles Times, July 22, 2020

Which Country Will Outperform? Here’s a Better Way

Investment opportunities exist around the globe, but the randomness of stock returns in different countries makes it almost impossible to predict which country’s stock market will outperform others. How should you manage that kind of uncertainty?

Approximately half of stocks globally represent companies outside the U.S. At the end of 2020, the stock market globally included more than 15,000 companies worth an aggregate $90 trillion, with about half (56%) of the value of all investible stocks in U.S. companies. The other half is comprised of developed ex U.S. and emerging stock markets. Most American investors tend to avoid non-U.S. stocks.1

Thinking how investors vote with their money after considering costs, expected return and risk, diversification, and their own tastes and preferences toward holding different investments, it’s useful to think in terms of countries allocated by percentages.

First, it’s a challenge, at best, to predict a country’s returns (much less those of a stock) by looking at past results, as shown by the performance of developed global markets (see Exhibit 1). In the past 20 years, annual returns in 22 developed counties varied widely from year to year. (Each color represents a different country, and each column is sorted top down, from the highest-performing country to the lowest.)

Exhibit 1: Most Favored Nations

chart grid of Most Favored Nations - Annualized Returns

Past performance is no guarantee of results. In USD. MSCI country indices (net dividends) for each country listed. Does not include Israel, which MSCI classified as an emerging market prior to May 2010. MSCI data © MSCI 2021, all rights reserved.

No predictable pattern is discernable in return by country from year to year. Each year, the best performing countries (with their underlying asset classes) can be found in different regions around the world. No evidence suggests that even professional investors can consistently identify in advance which countries will be that year’s outperformers.

Since 2000, among 44 developed and emerging markets countries, the U.S. market has never been the top performer. Some might find this surprising, given the size and reputation of the U.S. market. A counterintuitive example also may be found in emerging markets, where a prosperous country like China was the top stock performer among emerging market countries only once (2006).

Two examples from Exhibit 1 make the point well:

  • Austria posted the highest return in developed markets in 2017—but the lowest the next year.
  • The U.S. ranked in the top five for annualized returns over the entire 20 years. Yet it finished first in developed country rankings only once. In nine calendar years, the U.S. was in the lower half of developed market performers.

Global Diversification for Informed Planning

A diversified portfolio will never be the best or worst performing compared to its many components. Likewise, compared to performance of individual country components for planning an informed strategy, a diversified global portfolio can never be the best or worst performer in any year simply because it is a weighted average of those countries. The fundamental purpose of diversification is not to get to pick winners, but to offset extreme negative returns and increase the reliability of successful long-term outcomes by automatically including stocks that will happen to have high positive returns that year.

Investors should be very cautious about reducing global diversification in response to recent outperformance of a particular country, especially for U.S. investors with a strong home bias. Global portfolios will have periods of higher returns that a home country-specific portfolio will have. Attempting to predict when these periods will occur is likely to be a costly exercise in futility.

Results can change dramatically from year to year or decade to decade even in countries with a history of above-average returns. For example, since 2010, U.S. markets have been very strong performers and generally delivered higher returns compared with a global portfolio strategy and many other countries.

However, the prior 10 years — referred to as the “Lost Decade” for U.S. stocks — showed very disappointing results for those who concentrated in once popular American growth stocks. Over the 10-year period from 2000 to 2009, U.S. large stocks, as represented by the S&P 500 index, experienced an average negative return of -0.9 percent annualized, or a loss of 9% cumulatively. Adjusted for inflation, that was equivalent to -3.4 percent annualized or about -37 percent cumulatively.

Chasing media-hyped stocks or countries in response to a country’s or asset class’s recent performance — especially for families nearing or at retirement tempted to make U.S. stocks bets in hopes of even higher returns will make up for a lack of sufficient savings, are courting disaster.

Planning a Successful Conclusion

A successful financial experience need not depend on predictions or gurus as to which countries or asset classes will deliver the best returns for the next quarter, the next year, or even the next decade. Why? Because holding a dimensionally diversified portfolio of stocks from many markets worldwide — as opposed to a handful of countries or concentrating in just one — positions you to capture higher returns somewhere in the world wherever and whenever they happen. That outperformance will offset lesser performance that naturally occurs somewhere.

A truly informed globally diversified portfolio can provide more reliable outcomes for achieving retirement and legacy planning goals and give you greater peace of mind.

1.In US dollars. Market cap data is free-float adjusted and meets minimum liquidity and listing requirements. Data provided by Bloomberg. The World’s 10 Largest Stock Markets (October 29, 2020) Visual Capitalist Datastream, www.visualcapitalist.com/the-worlds-10-largest-stock-markets/

‘Everything Screams Inflation:’ Interpreting Headlines

KEY TAKEAWAYS

  • After last year’s many surprising shocks, sharp rebounds in prices this year should be no surprise.
  • Potential inflation is one among many factors to account for when setting a price at which to trade.
  • Looking at headlines from the past 50 years shows that reliably timing markets around inflation expectations is difficult, and sticking to a long-term planning strategy may be best.

How quickly things change.

Two years ago, the New York Times reported, “Federal Reserve officials are increasingly worried that inflation is too low and could leave the central bank with less room to maneuver in an economic downturn.”1 Recently, a Wall Street Journal article presented a sharply different view, with a headline that likely touched many raw nerves: “Everything Screams Inflation.” The author, a veteran financial columnist, observed, “We could be at a generational turning point for finance. Politics, economics, international relations, demography and labor are all shifting to supporting inflation.”2

Is inflation headed higher? In the short term, it has moved that way. With many firms currently reporting very strong demand for goods and services following last year’s abrupt collapse in business activity, prices are rising—sometimes substantially. Is this a negative? It depends where you sit in the economic food chain. Airlines once again enjoy fully booked flights, and many restaurants struggle to hire cooks and waiters. We should not be surprised that airfares and steak dinners cost more than they did a year ago, and that stock prices for JetBlue Airways and The Cheesecake Factory correspondingly surged over 150% from their lows in the spring of 2020.3

Do price increases like those signal a coming wave of broad and persistent inflation or just a temporary snapback following 2020’s unusually sharp downturn? We don’t know. But we know that future inflation is only one of many factors impacting prices. The market’s job is to take positive information, such as exciting new products, substantial sales gains, and dividend increases, and balance it against negative information, like falling profits, shortages, riots, and natural disasters, to arrive at daily prices that buyers and sellers mutually deem fair.

Let us assume for the moment that rising inflation persists. Some investors might choose to hedge against even higher inflation, while others might see it as a market timing signal and change their investments. But for traders to profitably time consistently, they need a trading rule that directs exactly when and how to revise their portfolios — “I’ll know it when I see it” is not a strategy. A trading rule based simply on some bureau’s inflation estimates is just a market-timing strategy dressed up differently. Successful timing requires that two predictions must be correct: when to change the portfolio and then when to change it back.

Having a negative outlook for stocks or bonds due to disconcerting information regarding inflation (or other conditions) is not enough. Current prices already reflect such concerns. Prices don’t change blindly. To justify switching a portfolio, you must be even more negative than the average investor. And then you must outsmart computer algorithms once again when the time appears right to switch back. And then repeat, over and over.

Documented evidence in of success pursuing stock timing strategies — by individuals and professionals alike — is conspicuous by its absence. Mutual funds and internet advice sellers advertise their winners and are silent about their losers.

Let’s illustrate the challenge: Imagine it’s New Year’s Day 1979. The overall US stock market4 produced a positive return in 1978 but failed to keep pace with that year’s 9% inflation for the second year in a row. Your crystal ball inerrantly foresees two years of back-to-back double-digit inflation for the first time since World War I.

What would you do? You painfully remember the losses of 1974, when the inflation-adjusted total return for US stocks was –35%, among the five worst annual returns since 1926.

We suspect many investors would begin to panic and sell stocks in anticipation of significantly lower security prices for the next two years. The result? Those who would have sold in fear likely failed to capture very high returns from both the equity and size dimensions of the U.S. stock market, as shown in Exhibit 1.5

Exhibit1: Looking Up

Cumulative Return, January 1979-December 1980

Chart: US Stock Market Cumulative Return, January 1979-December 1980

Past performance is no guarantee of future results. Indices are not available for direct investment. Source: Dimensional Fund Advisors Matrix Book 2021: Historical Returns Data — U.S. Dollars

Much recent inflation concern is linked to substantial increases in government spending and record levels of U.S. debt. Determining the appropriate levels is a contentious public policy issue, and its enormous importance should not be discounted. But the news items in Exhibit 2 suggest inflation concerns are not new. We believe the expected consequences of these issues are likely already reflected in prices of stocks and interest rates of bonds in publicly traded markets.

The future is never certain. But as economist Frank Knight observed 100 years ago, willingness to bear uncertainty is the primary reason investors have a profit opportunity.6 Investors will always worry about something. The possibility of unwelcome or unexpected events should be addressed by the structure of your portfolio’s design rather than by a hasty reaction to stressful headlines when they appear. As recent research highlights,8 staying invested with a dimensionally informed global strategy of a well-designed portfolio right for you is the most likely way to stay ahead of inflation, avoid costly mistakes and protect your lifestyle.

Exhibit2: Fears Through the Years

"Fears Through the Years" chart

FOOTNOTES

1Jeanna Smialek, “Fed Officials Sound Alarm Over Stubbornly Weak Inflation,” New York Times, May 17, 2019.

2James Mackintosh, “Everything Screams Inflation,” Wall Street Journal, May 5, 2021.

3Sourced using Bloomberg security returns. Low for Cheesecake Factory was April 2, 2020, and low for JetBlue was March 23, 2020.

4As measured by the CRSP 1-10 index.

5S&P data © S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved.

6Frank H. Knight, Risk, Uncertainty and Profit (Boston and New York: Houghton Mifflin Co., 1921).

7Headlines are sourced from various publicly available news outlets and are provided for context, not to explain the market’s behavior. This material is in relation to the U.S. market and contains analysis specific to the U.S.

8Dai, Wei and Medhat, Mamdouh, U.S. Inflation and Global Asset Returns (July 13, 2021). Available at SSRN: https://ssrn.com/abstract=3882899

Are Investor Concerns About Inflation Inflated?

KEY TAKEAWAYS

  • Recent academic-level research indicates that a globally diversified and structured investment strategy based on an array of assets classes would outpace long-term inflationary effects.
  • The protection offered by inflation-indexed securities appears to be the most effective for fixed-income allocation strategies designed to be sensitive to unexpected inflation.
  • The 1927–2020 study examined both double-digit and deflationary U.S. inflation periods.

US consumer prices were up by 5.4% for the year ending June 2021, the largest annual increase since August 2008.1 Naturally, inflation has gained much media attention and consequently that of ordinary Americans who’ve notice recent price increases in daily shopping and house prices.

Dimensional Fund Advisor’s recent paper “US Inflation and Global Asset Returns”2 provides good news for those planning retirement strategies intended to outpace long term inflationary price increases in services and goods. The study also contains sobering facts for those who believe that inflation may be hedged using so-called “alternatives.” Maintaining an informed globally diversified strategy is more likely to outpace long-term inflation, data suggest, and inflation-index securities can better complement an effective inflation-protected approach for successful long-term planning outcomes.

Inflation Outpaced

Exhibit 1 from the study shows average real returns (that is, returns net of inflation) for different asset classes in years with high (above-median) inflation from 1927 to 2020. The study considers a total of 23 U.S. assets that span bonds, stocks, industries, and underlying equity premiums. Over this period, inflation averaged 5.5% per year in “high-inflation” years. While average real returns (rather than nominal return figures having the illusion of greater returns) were mostly lower in high inflation years compared to years with low inflation, the exhibit shows that all assets except one-month T-bills — U.S. government short-term debt — had positive average real returns.

The analysis covering 1927–2020 is useful because it examines periods with double-digit US inflation (like the 1940s and ’70s) as well as periods with price deflation (like the Great Depression, 1929–32). The study found similar results over the recent 30-year period (1991–2020), when U.S. inflation was relatively mild and prices relatively stable. The recent period included expanded analysis including non-USD bonds, developed- and emerging-market equities, real estate investment trusts (REITs), and commodities. Overall, outpacing inflation long term has been the rule rather than the exception for common investment asset classes.

Exhibit 1: Keeping It Real

Average annual real returns in years with above-median US inflation, 1927–2020

graph: Keeping It Real Average annual real returns in years with above-median US inflation, 1927–2020

Source: Dimensional Fund Advisors. See Data Appendix below and links to the study for more information. Past performance is no guarantee of future results. Indices are not available for direct investment.

Inflation Risk, Hedged

Despite reassuring findings, disproportionately allocating to popular growth assets (selected based on recent past relative performance) would not be appropriate for most investors. Retirees and others sensitive to inflationary effects with a continuing need for reliable income and likely to have a lower tolerance for market volatility, should allocate greater exposure to inflation-indexed securities (such as TIPS and inflation swaps) specifically managed to provide inflation protection. While stocks from certain industries, REITs, commodities, and value stocks may be promoted by some as “inflation-sensitive,” the evidence does not show that they are reliable inflation hedges for informed planning applications.

Nominal asset prices on which investors based their purchases already embed the market’s current expectation of inflation. So investor inflation concerns really should be about the negative impact of unexpected inflation on the real value of your wealth. A true inflation “hedge” will have its nominal returns closely aligned with unexpected inflation. The study importantly showed only weak correlations between nominal returns and unexpected inflation. Exceptions included energy stocks and commodities, but their nominal returns were around 20 times as volatile as inflation, as many other factors impact their pricing. Exhibit 2 shows how widely their nominal returns often differ from actual inflation.

Exhibit 2: Deflating Inflation “Solutions”

Annual US inflation along with nominal returns to energy stocks and commodities, 1991–2020

graph:Deflating Inflation “Solutions” Annual US inflation along with nominal returns to energy stocks and commodities, 1991–2020

Source: Dimensional Fund Advisors. See Data Appendix below and links to the study for more information. Past performance is no guarantee of future results. Indices are not available for direct investment.

Inflation Severity Deflated

What will next month’s or next year’s reading of inflation be? Is the current rise in inflation temporary as government officials claim or stubbornly long-lived? Nobody has a crystal ball. Fortunately, you don’t need a crystal ball to effectively address the impact of expected or unexpected inflation with an informed portfolio strategy. Staying invested with a dimensionally allocated strategy based on financial science and decades of academic evidence, skillfully managed, will likely outpace inflation for long-term planning purposes. Whether you save enough or spend prudently for your goals depends entirely on you and your personal situation.

For those of you particularly sensitive to the impact of unexpected inflation for planning retirement income, incorporating longer-dated inflation-indexed income strategies in coordination with techniques like reverse mortgages and long-term care insurance for flexibility in spending due to idiosyncratic risks mostly related to health, would likely be the most successful long-term inflation “hedge” to incorporate for planning to protect your lifestyle and financial security.

FOOTNOTES

1.Based on the US Consumer Price Index for All Urban Consumers (CPI-U, not seasonally adjusted) from the Bureau of Labor Statistics.

2.Dai, Wei and Medhat, Mamdouh, US Inflation and Global Asset Returns (July 13, 2021). Available at SSRN here.

DATA APPENDIX

US inflation

The annual rate of change in the Consumer Price Index for All Urban Consumers (CPI-U, not seasonally adjusted) from the Bureau of Labor Statistics.

US government securities and long-term corporate bonds

The returns to US government securities (one-month T-bills, five-year notes, and long-term bonds) and long-term corporate bonds are from Morningstar (previously from Ibbotson Associates).

US equity portfolios and factors

The US equity market is proxied by the Fama/French Total US Market Research Index. The US industry portfolios are the 12 Fama/French industry portfolios. The US style portfolios (small cap value and growth and large cap value and growth) are from the Fama/French six portfolios sorted on size (market cap) and book-to-market equity. The US size and value premiums are proxied by the Fama/French size and value factors. The returns to all of the above are from Ken French’s data library here.

The 1920s Florida Property Bubble

Whether it’s the tulip mania of the 1620s, the railway boom of the 1840s, the dot-com craze of the 1990s, or today’s cryptomania and astronomical prices for SPACs, financial bubbles have been around as long as markets existed. Before a media narrative or envy tempts you, recognize that the next generation of financial booms and busts always come in a new shape and form, but the end of the story is invariably a loss of the investors’ hope and money.

With housing prices in Rochester and many smaller metro areas rising to record highs, a real estate bubble that eventually turned out extremely well many years later may help you make more thoughtful decisions. One forgotten story is the Florida property boom of the 1920s and illustrates well how hastily chasing a great idea can lead early investors into financial waste.

The Wild, Wild (Key) West

In 1918, the United States emerged from the ruinous “Great War” — World War I — as the wealthiest nation on the planet with great confidence about the future. What may have been the best decade of the 20th century soon followed: the Roaring ’20s.

The country was prosperous as never before. New consumer technologies like the automobile and the radio were changing daily life. A growing urbanized middle class had money to spend like never before. The freewheeling atmosphere in the big cities and easy access to credit to exploit the general optimism made conditions ripe for a financial mania.

Henry Flagler, John D. Rockefeller’s former business partner, had extended his railways from the north into West Palm Beach and Miami. By 1912, they had reached Key West — hailed at that time as the most extraordinary engineering feat in U.S. history.

America’s well-heeled soon flocked to Florida instead of France’s Côte d’Azur, off-limits because of the Great War in Europe. The expansion of railroads and the paved Lincoln and Dixie highways for the new automobiles allowed for the arrival of a new type of tourist. This created the perfect conditions for an astonishing land boom in Florida.

From Uninhabitable to Idyllic

As Harvard economist John Kenneth Galbraith observed, “The Florida land boom was the first indication of the mood of the Twenties, the conviction that God intended the American middle class to be rich.”

If Flagler was hailed as the father of Miami, Carl Fisher was the father of Miami Beach.

Before 1913, Miami Beach was a narrow strip of worthless jungle infested with snakes and mosquitoes. The only way to reach the oceanfront was by excursion boat. In less than a decade, this island — 10 miles long and 3 miles wide — was transformed into the “American Riviera,” an exclusive world inhabited by moneyed industrialists of new consumer products and stars of stage and screen produced by the innovation of movie theaters.

Fisher opened The Flamingo Hotel on New Year’s Eve in 1920. The following year, President Warren Harding stayed at one of the hotel’s luxury cottages. He even played golf aided by an unusual caddie — a baby Asian elephant named Rosie.

Fisher had transformed Florida’s image from a land of swamps into a newly discovered paradise by the sea. Boosted by loose credit conditions, a healthy economy and Fisher’s relentless promotion, property prices rose. A land boom ensued, supported by hype and marketing campaigns that infatuated the national media and helped advertising revenues.

Other property developers followed Fisher’s example.

George Merrick, the founder of the idyllic Coral Gables in Miami, even employed silver-tongued former presidential candidate William Jennings Bryan for credibility to convince buyers to move there.

Every day, Bryan would remind prospects that “Miami was the only city in the world where you could tell a lie at breakfast that would come true by evening.”

The promise of massive gains in real estate lured speculators from all over America. By 1925, Miami had 25,000 estate agents working out of 2,000 offices.

The money being made by some people in real estate during those boom days was staggering. Building lots in downtown Miami sold for $1,000 in the early 1900s. By 1925, they sold for between $400,000 and $1 million. Lots in prime locations, such as Flagler Street, ran as high as $70,000 per linear foot. Lots that were 2 miles from the city center had sold for $2,500 a few years earlier yet commanded more than $50,000 in 1926.

Investment advisor Roger Babson wrote, “There were more Rolls-Royces and Lincolns in the state of Florida in 1926 than in any other state in the country.” In the summer of 1926, the Miami Daily News published a single issue that was a whopping 504 pages, mainly consisting of real estate advertisements. It weighed 7.5 pounds.

The boom even led to the rise of a new kind of financial instrument — the Bitcoin of its day. “Binder boys” would show land to prospective buyers. Buyers, in turn, could effectively buy options on the land by paying a “binder,” a nonrefundable deposit due within 30 days. Rather than pay off the balance, the land buyer would often “flip” the binder for a profit to someone else. Binders on lots in Miami were bought and sold as many as 10 times a day.

A Great Opportunity Busted

But the boom eventually turned to bust, as we know with hindsight. In late 1926, the supply of buyers dried up. Many who had bought binders suddenly couldn’t find anyone to sell them to. Newspaper reports began to warn of Florida land scams. Attention turned to the New York financial markets where soaring stocks could be bought and sold on “margin.”

And things got still worse…

A pair of disastrous hurricanes in 1926 and 1928 destroyed much of greater Miami in addition to hitting Hollywood and Fort Lauderdale. By 1931 as the Great Depression was in full force after the great stock market crash of 1929, about three-fourths of the banks in Florida had gone bankrupt. The Florida land boom left behind entire new cities, such as Coral Gables, Palm Beach and Hollywood.

Yet Florida’s leading lights suffered bankruptcy and crippling alcoholism. Addison Mizner, the founder of Boca Raton, was broke by 1930. Merrick died at 55, leaving a paltry estate of $400. In the late 1930s, an associate saw Fisher loitering on a park bench in Miami Beach. “I’m a beggar — dead broke,” Fisher told him. “No family to fall back on.”

And many more investors — especially those late to the party and small-time speculators — lost a fortune investing in the much-hyped “Florida dream.” With Florida property prices soaring once again in 2021 as well as elsewhere, the 1920s Florida land boom still offers sobering lessons for those hoping to get rich quick on a new set of “market opportunities.”

I still recall the big brokerage marketing schemes that left many early retirees of Kodak and Xerox with very little retirement money in the aftermath of the Dot.com Bust. Yes, eventually some investors did make dot.com fortunes, but how many predicted with their life savings that Amazon would become the biggest dot.com winner after dropping 95% but could not stay invested until that happened years later?

Should Investing Strategies Include Cryptocurrencies?

Bitcoin and lesser-known cryptocurrencies are receiving intense media coverage these days. Many wonder whether this electronic “money” represents a “paradigm shift” and should deserve a place in their planning strategy. While their prices have soared, that is the past. What about the future?

Cryptocurrencies surely represent a financial services innovation, but many uncertainties surround their technology potentially impacting returns that investors may realize. While promoters point out spectacular price gains, that increase creates no price floor. Furthermore, the total value of all tradeable cryptocurrencies is miniscule relative to the global aggregate value of all stocks and bonds, so the allocation in diversified portfolios should be small.

For much of the past decade, cryptocurrencies were the preserve of a small group of digital enthusiasts and those who believed that fiat currencies were coming to an end. This niche appeal is reflected in their market value. For example, at a market value of $57,000 per bitcoin,1 the total value of bitcoin in circulation is less than half of a percent of the value of all investible stocks and bonds.

Cryptocurrencies such as bitcoin have only recently emerged, and there are thousands out there. Dogecoin (DOGE), with little practical use, has a market cap of $65 billion. Unlike traditional currency, no paper notes or metal coins are issued. No regulator or nation state stands behind any of them, and no central bank is involved. Highly debated variables should be considered, such as difficult technological nuances. Some users have lost access to millions of dollars’ worth of bitcoin simply due to forgotten passwords that can’t be rectified.2 You can’t just call your local bank or brokerage firm to help you. Investors in regular stocks and bonds are not accustomed to such issues. Tax calculations also are a filing nightmare.

Cryptocurrencies exist only as a form of computer code and are stored in a “digital wallet.” Bitcoin has a finite supply of 21 million,3 of which more than 18.5 million are in circulation.4 Transactions are recorded on a decentralized public ledger called a “blockchain” with complex algorithms to validate these entries.

People can earn bitcoins in several ways. That includes buying them using traditional government-backed currencies3 or by “mining” them — receiving newly created bitcoins as payment for the use of powerful computers to compile additional transactions into new “blocks in the transaction chain” through solving a highly complex mathematical puzzle.

Expected Returns

Stocks and bonds are considered “productive assets” unlike cryptocurrencies. The value of those securities comes from future cash flows generated from activities with presumed economic value. Companies seek external sources of capital to finance projects intended to generate future profits. When a company issues stock, it offers investors a residual claim on a proportionate share of future profits earned. When an entity issues a bond, it promises investors a stream of future cash flows, including future repayment of principal when the bond matures. The price of a stock or bond reflects the return the marginal investor demands to exchange their cash today for an uncertain amount of cash expected in the future.

Most government bonds, compared to corporate bonds, provide a more certain promise of payments as cash flows. That greater certainty of positive expected returns is an important reason to hold government bonds reduces the volatility of future cash flows when planning for income.

Unlike bonds, holding cash provides no expected stream of income. One US dollar in your wallet today does not entitle you to more dollars in the future, no matter how long you hold it. The same is true for holding a digital currency like bitcoin in a digital wallet. Holding cash in either form has no expected return or expected stream of income, except as currencies unpredictably appreciate or depreciate relative to each other. Cash is a useful store of value only to manage near-term expenditures in the same currency. However, most goods and services are not priced in bitcoins.

The exchange rates between bitcoins and traditional currencies involves enormous levels of volatility. Bitcoin has gained or lost more than 40% in price in a month or two. High volatility implies a high level of uncertainty in the amount of future goods and services that bitcoins can purchase. This heightened uncertainty, combined with high transaction costs for converting bitcoins into usable currency, implies that cryptocurrencies fall very short as a means for managing near-term, much less daily, expenses.

Supply and Demand

The price of a bitcoin is tied to the forces of market supply and demand. Although the supply of bitcoins is slowly rising, it may reach an upper limit and stop future supply. The future supply of cryptocurrencies as sector, however, may be very flexible: new types are developed and technological innovation makes many cryptocurrencies close substitutes, implying that future supply of “cryptocurrencies” may be unlimited.

Future demand for bitcoins if unpredictable: there is a non‑zero probability5 that nothing will come of it (no future demand) and a non-zero probability that it will be widely adopted (high future demand). Buying and selling something based only on what others guess its future worth might be is not investing — it is speculation.

Future regulation increases the uncertainty. As far back in 2014, the U.S. Securities and Exchange Commission warned potential investors that any new exciting and cutting-edge investment has the potential to give rise to fraud due to implied false “guarantees” of high investment returns.6 Cryptocurrency SCAM, created as a joke, has a market cap of $2.5 million. It is unclear what impact future laws and regulations in different jurisdictions may have on any cryptocurrency or even its continued existence.7 The Fed recently asserted that research on the digitalization of the U.S. dollar is a “very high-priority project.”8

But probabilities of high or low future supply or demand are only one input into bitcoin prices. Today’s price is fair, given that investors willingly transact at that price. No investor has an unfair advantage over another in knowing the true probability of future demand reflected in bitcoin’s price today.

Exhibit 1: The Risk Continuum

Risk Continuum graphic

What to Expect

So, will cryptocurrencies continue to appreciate? Perhaps, just as Federal Reserve easy monetary policies fueled other financial booms as well as today’s bubbling stock boom. Stock valuations have risen to their richest levels since the dot-com bubble in 2000. The Fed has kept interest rates artificially near zero for the past year and signaled those rates will not change for at least two more years. Consequently 10-year Treasury bond yields are well below current inflation. Risky companies borrow at the lowest rates on records. This encourages speculation in cryptocurrencies as well in this environment.

In the framework for planning a diversified portfolio strategy for retirement or other goals, financial theory suggests that the baseline for portfolio design should be the weight of all investable securities in the global market. A goals-based approach based on stocks, bonds, and traditional currencies integrated with robust dimensions of expected returns has helped many informed investors successfully pursue financial experiences.

In the short term, cryptocurrencies may outperform other investments. Even if blockchain technology is here to stay, it is not clear that cryptocurrencies will last in their present form. Unlike stocks or bonds, cryptocurrencies do not offer positive expected returns for growing wealth and reducing allocations to traditional securities like stocks and bonds that do. And they do not allow for easy exchanges for near-term expenditures as do traditional cash equivalents. Therefore, we do not believe cryptocurrencies warrant a place in most portfolios.

When reading the latest headline or experiencing FOMO due to a friend getting rich, consider that sticking with informed strategy grounded in modern financial science is a more reliable long-term strategy for wealth planning. Studies in the aftermath of the dot-com bust twenty years ago found that almost all the big winners publicized in popular magazines had very little left to show of all their paper wealth. Don’t confuse a playcheck with your future paycheck in retirement.

  1. Per Bloomberg, the end-of-day market value of bitcoin was $57,698 USD on May 7, 2021.
  2. Nathaniel Popper, “Lost Passwords Lock Millionaires Out of Their Bitcoin Fortunes,” New York Times, January 12, 2021.
  3. Source: Bitcoin.org.
  4. As of March 12, 2021. Source: Coinmarketcap.com.
  5. Describes an outcome that is possible (or not impossible) to occur.
  6. “Investor Alert: Bitcoin and Other Virtual Currency-Related Investments,” SEC, 7 May 2014.
  7. James Areddy, “China Creates Its Own Digital Currency, a First for Major Economy,” The Wall Street Journal, April 5, 2021.
  8. Greg Ip, “What Happens to Stocks and Cryptocurrencies When the Fed Stops Raining Money?” Wall Street Journal, May 8, 2021.

From the New Normal to the Next Normal

A year ago, at the end of March 2020, the S&P 500 was down nearly 20%1 and the world was going into lockdown. Many experts and economists wrote about where we would be in a year. I don’t remember anyone predicting that the S&P 500 Index would be up 56% only 12 months later or that the broad U.S stock market be up over 62%. But that’s what happened.

I avoid making forecasts. Researchers examining how stock markets responded after past recessions have learned almost nothing useful. We should simply expect severe market downturns occurring once or twice a decade, while accepting the “old normal” that we can never know when or how much that will be. Diversified investors are rewarded for their willingness to endure risk, not to avoid it.

What lessons can be taken away from last year that will better prepare you for the next time? People say, “It’s different this time.” They’re right. It is different every time. Arbitrary government decisions fearing many pandemic deaths precipitated a market crisis. The first crisis I recall was in the 1970s: inflation, oil, and Vietnam. Then there was the savings and loan crisis, Black Monday, the Asian contagion crisis, the dot-com bubble, 2008 financial panic, and recently the Christmas stock massacre. The list will not end. Every market crisis is unexpected. Crises keep occurring because the events triggering them aren’t predictable. If market downturns were predictable, stock market prices would have already adjusted. That’s inherent in the nature of forward-looking price-setting in well-functioning capital marketplaces everywhere around the world.

No one can predict when the next “black swan” event will trigger a market crisis. But you should thoughtfully structure your investment planning well before that occurs. The first principles of addressing uncertainty of stock and bond market outcomes is considering the likelihood of various outcomes, and then deciding how much volatility you can tolerate. We can’t control what crises occurs, but we can control our emotional response by having a smart strategy in place. You need a systematic process guided by a trusted advisor that will keep your emotions in control even when events seem out-of-control. This is the “next normal” for you.

For clients of Professional Financial who stuck with their planning and suffered the pain, it’s time to celebrate the gain. For instance, Dimensional’s US Core Equity 2 Portfolio, which holds a diversified mix of U.S. equities and is their largest core portfolio, returned nearly 72%, as Exhibit 1 shows. Within the U.S. market, small cap value stocks2 were among the hardest hit in the crisis. Dimensional’s concentrated US Small Cap Value Portfolio was down 39% in the first three months of 2020 but subsequently returned a showstopping 112% over the next 12 months. (The broader US Vector Equity Portfolio with substantial small value stock positions was up 84%.)

Exhibit 1: Rise and Shine: Dimensional Funds vs. Benchmarks

Cumulative Returns

table,  Exhibit 1: Rise and Shine: Dimensional Funds vs. Benchmarks Cumulative Returns

Performance data shown represents past performance and is no guarantee of future results. Current performance may be higher or lower than the performance shown. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. To obtain performance data current to the most recent month-end, visit us.dimensional.com.

Sticking to long-term planning strategy in the face of an unprecedented situation wasn’t easy. Last March stressed everyone. There was enormous social and media pressure to “do” something. Many retired and near-retirement investors have come to hold very substantial positions in stocks, ETFs or alternatives. They believe that market-based securities are their best income option to low returning bank CDs or government bonds. Inexperienced investors, as stocks and even bonds dramatically declined and internet media played on their fears, quickly cashed out to reduce their uncertainty.

Investors realized only too late that selling out to “protect their principal” only increased their uncertainty. Holding cash and seeing fixed on the latest news, they are forced to make a second even more difficult decision: choosing the best time to get back in. By putting off that decision until the newscasts signaled that investing was “safe,” most of what those sellers previously earned from investing had disappeared.

The price of a market education is very high. Many who “invest” in risky assets are gambling. If you’re trying to time short-term market movements or picking stocks or ETFs, you’re gambling. You are betting that you know more than the smartest market participants with the fastest computers. Would-be gamblers must never forget—in the end, the house always wins. Getting rich quick by luck doesn’t mean you stay rich.

Staying focused on long-term expected outcomes during any challenging time is hard. Investing on your own is hard. Watching the daily market movements of 2020’s horrible first quarter gave no signal of astonishing returns yet to come. Future returns after the end of March could not be known, and we surely did not know.

But based on decades of research and experience, we knew that the only hope of a successful financial outcome from the crisis was maintaining a consistent risk exposure through dimensional-style allocation strategies, planned well in advance. Only then could clients confidently hope to capture their share of returns whenever they eventually showed up. And show up they did, big time. Those who stuck with their planning philosophy and process, got far more of their share of gain than they ever expected—putting them comfortably back on track for financial and retirement lifestyle goals.

Our role as CFP® professionals — trusted fiduciaries who put your best interests first and foremost — is informing you of possible planning outcomes when developing, structuring, and managing a wealth strategy tailored to your unique values, goals, and preferences. In putting a plan in place, you need to be realistically confident of a reliable range of results so you can safely ignore the news media. The oldest media trick to gain viewership is playing on your deepest fear of dying broke. Wealth management that Professional Financial provides accounts for extreme challenges that you may face, so you may have peace of mind, knowing the difference between investing and gambling.

What is the Next Normal? It’s expecting uncertainty in the normal course of investing. It’s committing to strategy with a plan and process that incorporates those possibilities. It’s positioning you to rise above the temptation to make reactive changes in tough times. And it’s knowing how great it feels to experience successful financial outcomes again and again, so that you and your family can look forward with confidence, rather than fear.

If you are not confident that your strategy considers the unexpected and uncertainty in its range of planning outcomes, and were not happy last year, it may not be too late. Perhaps the crisis was an expensive learning experience. Worse may still come. But true wealth management that we provide prepares you not only for living in the New Normal, but just as important, prepares you to experience the Next Normal with confidence.

Exhibit 2: Performance as of March 31, 2021

Table, Exhibit 2:  Exhibit 2 Performance as of March 31, 2021

RISKS: Investments involve risks. The investment return and principal value of an investment may fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original value. Past performance is not a guarantee of future results. There is no guarantee strategies will be successful.

  1. S&P data © 2021 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. Indices are not available for direct investment. Index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment. Decrease of 19.6% was from Jan. 1, 2020–March 31, 2020. Increase of 56.35% was from March 31, 2020–March 31, 2021.
  2. As defined by the Morningstar Small Cap Value Category.

Before Investing in Crypto Currencies, Read This

sample image of website banner touting bitcoin purchasing

(Sample Advertisement)

Bitcoin and similar cryptocurrencies (now numbering in the thousands) are the subject of much popular debate and media attention. Can something that exists only in cyberspace truly be equivalent to gold? Given bitcoin’s dramatic price changes, up and down, as well as promotional advertising like the sample above, it is not surprising that many are speculating about its possible place in portfolio designs. Who is more likely to gain wealth—the crypto creators or their buyers?

“Everything you don’t understand about money combined with everything you don’t understand about computers.” — HBO’s Last Week Tonight with John Oliver, March 11, 2018

Exhibit 1: Bit Player

Price of bitcoin for the last 10 years, March 2011–February 2021

illustration, Exhibit 1: Price of bitcoin for the last 10 years, March 2011–February 2021

Source: Dimensional Fund Advisors. This material is not to be construed as investment advice or a recommendation to buy or sell any security or currency. Investing involves risks including possible loss of principal. There is no assurance that any investment strategy will be successful. Past performance is no assurance of future results.

During its relatively short existence, bitcoin has proved extraordinarily volatile, sometimes gaining or losing more than 40% in price during a month or two. Any asset class subject to such sharp swings may be a narcotic for traders but of limited value either as a reliable medium of exchange (to replace cash) or as a risk-reducing or inflation-hedging asset in a diversified portfolio (to replace bonds).

Assessing the merits of bitcoin in a portfolio strategy can be problematic. Adding it to a portfolio could mean reducing the allocation to conventional investments such as stocks, property, or fixed income. The owner of stocks or real estate generally expects to receive future income from dividends or rent, even though the size and timing of the payoff may be uncertain. A bondholder generally expects to receive interest payments as well as the eventual return of principal. In contrast, holding bitcoin is much like holding gold. Even if bitcoin or gold are held for decades, the owner may never receive more bitcoin or gold. Also unlike investments based on stocks and bonds, it is not clear that bitcoin offers investors positive expected returns regardless how long the owners hold onto it.

Putting aside squabbles over the future value of bitcoin or other cryptocurrencies, there are other sobering issues investors should consider impacting their financial security:

  • Bitcoin is not backed by a governmental issuing authority and exists only as computer code, generally resides in a so-called “digital wallet,” accessible through a password chosen by the user. Many of us have forgotten or misplaced computer passwords from time to time and have had to contact the sponsor to restore access. No such avenue is available to holders of bitcoin. After a limited number of password attempts, a user can permanently lose access. Since there is no central authority responsible for bitcoin, there is no recourse for the forgetful owner: a recent New York Times article profiled the holder of more than $200 million worth of bitcoin that he can’t retrieve. His anguish is apparently not unusual — a prominent cryptocurrency consulting firm estimates that 20% of all outstanding bitcoin represents stranded assets unavailable to their rightful owners.1
  • Mt. Gox, a Tokyo-based bitcoin exchange launched in 2010, was at one time the world’s largest bitcoin intermediary, handling over one million accounts in 239 countries and more than 90% of global bitcoin transactions back in 2013. It suspended trading and filed for bankruptcy in February 2014, announcing that hundreds of thousands of bitcoins had been lost and likely stolen.2
  • The UK Financial Conduct Authority cited numerous concerns as it prohibited the sale of “cryptoasset” investment products to retail investors last year. Among them were the inherent nature of the underlying assets, which have no reliable basis for valuation; the presence of market abuse and financial crimes in cryptoasset trading; extreme price volatility; an inadequate understanding by retail consumers of cryptoassets; and the lack of a clear investment need for investment products and referenced them.3

The financial services industry has a long tradition of innovation. Cryptocurrency and the technology surrounding it could prove to be a historic breakthrough in coming years. For those who enjoy the thrill of speculation, trading bitcoin may hold considerable appeal. But those seeking financial security and peace of mind in planning for a secure retirement should consider the concerns of the UK Financial Conduct Authority above before making a serious investment.

Reserve your gambling for Las Vegas or Niagara Falls.

  1. Nathaniel Popper, “Lost Passwords Lock Millionaires Out of Their Bitcoin Fortunes,” New York Times, January 12, 2021.
  2. Alexandra Harney and Steve Stecklow, “Twice Burned – How Mt. Gox Bitcoin Customers Could Lose Again,” Reuters, November 16, 2017.
  3. “Prohibiting the sale to retail clients of investment products that reference cryptoassets,” Financial Conduct Authority, June 10, 2020.

Gauging Market Expectations?

A recent flurry of return spikes for a handful of U.S. stocks has captivated investors and non-investors alike. Wall Street news trending on social media even amid an NFL playoff season is indeed an unusual event.

So, what should investors make of these dramatic price movements? A good place to start is with prices themselves. Prices reflect discount rates applied to the expected future cash flows of companies. One can interpret these discount rates as the expected return demanded in aggregate by market participants to hold shares of a company.

Discount rates for a stock incorporate a potentially massive number of viewpoints about the company. Equity markets processed over $653.4 billion worth of trades on an average day in 2020. The result of such activity is prices reacting to a vast amount of information relevant to discount rates.

The link between prices and expected future cash flows through discount rates gives us a framework for interpreting changes in prices. If a stock’s price goes up, either expectations of cash flows have gone up or the discount rate went down. In the case of the latter, a stock price moving higher means lower expected returns.

Aggregate demand for securities, and therefore discount rates, can be driven by many variables. Investors may assess a company’s exposure to myriad risks, such as sensitivity to macroeconomic variables (inflation, interest rate changes, GDP growth, etc.), its volatility, and susceptibility to regulatory changes, just to name a few. The riskier the investment, the higher the discount rate.

But investor tastes and preferences also play a role in setting discount rates for securities. If market participants prefer one company over another, the rate of return demanded to hold that company’s stock may be lower than another stock for that reason alone. This effect is analogous to color preferences of car buyers; if enough shoppers are averse to primary colors, you may be able to get a relative discount on that new, bright-yellow car!

Nearly a century of empirical data tells us that we can use market prices to systematically identify stocks with higher expected returns. This approach is indifferent to the specific considerations driving differences in discount rates. And the evidence for relying on market prices spans a history of different economic environments, market infrastructure evolution, and regulatory changes.

What hasn’t generally benefited investors is attempting to outguess markets and identify mispriced securities. The degree of difficulty in anticipating market movements more quickly and effectively than the millions of other market participants is consistent with the paucity of professional investment managers that have been able to outperform passive benchmarks. For investors, this means time is probably better spent scrolling past the news on stock price spikes and going back to arguing about who will win the Super Bowl.

Disappearing Dividends During the Year of COVID-19

Many investors view dividend payouts as a reliable source of income, and construct portfolios emphasizing stocks that pay above-average dividends. This strategy has become common among many conservative investors over the past decade as bank interest rates and returns on government bonds have progressively approached zero.

Greatly reduced bond and bank returns has made a formerly common bond-only approach impractical among risk-adverse investors for achieving their essential retirement income goals. Since high-dividend stocks were often companies issuing bonds familiar to risk-adverse investors, a high dividend stock approach quickly captured much interest among retirees highly dependent on their portfolios for income. Over time, investors bid up the prices of those stocks as the broader market rose, effectively reducing the level of return relative to share prices, causing disappointment among retirees coming in later and wanting to increase their positions.

But it gets worse. Bonds have promised payouts; dividends for stocks are not guaranteed. So retirees expecting a regular flow of income from dividends from their stocks were surprised to see reduced or suspended dividend payouts following the coronavirus pandemic onset. Both market declines and volatility were extraordinary and selling stocks with declining dividends was not an option. Research and historical data show that changes in dividend policy by firms are common, especially during times of higher business uncertainty when cash on hand must be retained for survival.

Aggregate dividend payouts fell meaningfully in the first three quarters of 2020 compared to the same period in 2019. Exhibit 1 shows the dividends earned from a hypothetical $1 million investment in US, developed ex-US, and emerging markets in both periods. Developed ex-US markets showed the most drastic change with a 41% decrease. Dividend payments in emerging markets decreased by 29% and in US markets by 22%.

Exhibit 1: Drop Zone
Dividends from a Hypothetical $1 Million Investment

Graphic, Exhibit 1 - Drop Zone - Disappearing Dividends During the Year of COVID-19 - View From the Hill, Dec. 2020

Source: Calculated by Dimensional Fund Advisors LP from Bloomberg data. In USD. Each hypothetical investment includes all securities in the investable equity universe in the applicable region at free-float market cap weight as determined at the beginning of each year. To be included in the investable equity universe, securities must meet certain minimum capitalization and liquidity requirements. Investment companies are excluded. Past performance, including hypothetical performance, is no guarantee of future results.

Worldwide, large established firms have historically had the highest propensity to offer substantial dividend payouts.1 But even successful, well-established firms were not immune to the economic consequences of governmental response to a global pandemic. A few examples will illustrate. Harley Davidson (HOG) has been paying dividends to shareholders since the 1990s. In April 2020, the motorcycle manufacturer slashed its dividend from $0.38 per share to just $0.02, a 95% decrease.2 Gap Inc. (GPS) suspended its dividend payments until at least April 20213 after the economic downturn left the clothing brand with particularly poor revenues.

Exhibit 2: Changing Tune
Dividend Policy Changes in Global Markets (% of Dividend-Paying Firms), 2020

Graphic, Exhibit 2 - Changing Tune - Drop Zone - Disappearing Dividends During the Year of COVID-19 - View From the Hill, Dec. 2020

Source: Calculated by Dimensional Fund Advisors LP from Bloomberg data. Dividend-paying firms include all firms that have paid a dividend in the preceding 12 months and were expected to pay a dividend in the current quarter. In USD.

Harley Davidson and Gap were not the only firms to change their dividend policies. As shown in Exhibit 2, 38% of firms in global markets (2,584 companies) that were expected to pay dividends consistent with their payout history, instead decreased, omitted, or eliminated their dividend payments in the second quarter, more than doubling the 1,248 firms that made similar changes to their dividend policy in the first quarter of the year. The trend continued into the third quarter: 2,699 firms made such changes.

While these dividend cuts may come as a surprise to some retirees, history buffs may recall that, in 2009, Harley Davidson announced it was cutting dividend payouts from $0.33 per share to $0.10, a 70% decrease.4 In fact, during the Great Recession years, significant changes to firms’ dividend policies spiked throughout the global markets.

Exhibit 3 displays Fama/French global market returns for 1991–2019 with a one-year lag and the proportion of dividend-paying firms that eliminated or decreased their dividend payouts. In 2008, for example, the global market was down more than 40%, and, the following year, many firms made changes to their dividend policies. The historical correlation between global market returns and dividends that are decreased or eliminated suggest that firms are likely to alter their dividend payouts during times of market instability. Intuitively this makes sense.

Exhibit 3: In Step
Global Market Returns and Dividend Changes

Graphic, Exhibit 3 - In Step - Disappearing Dividends During the Year of COVID-19 - View From the Hill, Dec. 2020

Note: Global Market return is free-float market cap weighted average of Fama/French Developed Markets and Emerging Markets Indexes. See Index Descriptions in the disclosures for descriptions of Fama/French index data.
Source: Calculated by Dimensional Fund Advisors LP from Bloomberg data. Past performance is no guarantee of future results. Dividend paying firms include all firms that paid a dividend in the prior calendar year.

The first three quarters of 2020 remind us once again that past performance is never guaranteed. Dividend payouts can be inconsistent, particularly during times of uncertainty. Hence, investment strategies that focus on income derived from dividends may not well serve those who need a steady income stream during retirement. Moreover, that approach is unlikely be an effective way to confidently pursue long-term wealth growth.

We believe a more reliable planning approach for greater confidence of success during retirement, in addition to other planning strategies, is to structure a portfolio asset allocation strategy around stock’s fundamental characteristics that decades of economic research has demonstrated drive higher expected returns: size, relative price, and profitability, while maintaining broad diversification across names, sectors, and countries plus carefully controlling costs and taxes. A sensible, systematic process solidly grounded in an informed economic philosophy is much more likely to provide retirees a successful financial experience and greater peace of mind.

Disclosures: Index Descriptions: Fama/French Developed Markets Index: July 1990–present: Courtesy of Fama/French from Bloomberg securities data. Companies weighted by market cap; rebalanced annually in June.

Fama/French Emerging Markets Index: July 1989–present: Courtesy of Fama/French from Bloomberg and IFC securities data. Companies weighted by float-adjusted market cap; rebalanced annually in June.