Staying the Course

Neil Gartner |

“In investing, you get what you don't pay for. Costs matter. So intelligent investors will use low-cost index funds to build a diversified portfolio of stocks and bonds, and they will stay the course. And they won't be foolish enough to think that they can consistently outsmart the market.”

John C. Bogle1

Much of what I’ve learned about investment portfolio construction has been tested over the past two years.       

In 2022, the overall U.S. stock market returned a negative 20% as the U.S. Federal Reserve (“Fed”) raised interest rates rapidly and substantially to fight accelerating inflation.  Even well-diversified, conservatively allocated stock and bond portfolios experienced double-digit declines.

In 2023, the Fed’s efforts looked to be paying off as inflation moderated and markets rebounded.  However, for much of 2023, headline stock market gains were driven largely by the “Magnificent Seven” large tech companies.3  Returns from diversified portfolios were more muted.4

It’s been a rough ride, reinforcing the investing truth that there is no perfect portfolio that will outperform in all market conditions.  After a careful review and analysis, GFA will “stay the course” and continue to follow time-tested investment principles we believe offer a high probability of solid, inflation-beating returns over the longer term.  (Forgive the copious footnotes – my compliance guy made me do it! 😊) 

  1. Indexing is smart.  Indexing involves buying all the securities in a particular asset class.  No effort is made to pick and choose winners and losers – the fund buys them all.  An S&P 500 index fund is a well-known example – it buys all 500 of the largest U.S. stocks as ranked by Standard & Poor’s. To beat a simple indexing strategy, an ‘active” investment manager (or you) must see something in a company that will cause its stock to do better or worse than the future performance implicit in the current market price.5 It turns out that beating the market’s collective wisdom about the “right” price to pay for a stock is really hard, even for professionals: 90% of actively managed U.S. stock funds fail to beat their relevant unmanaged benchmarks6.  Sure, every year some managers will beat their benchmark, but consistent outperformance is exceedingly rare.

  2. Diversify widely.  The Magnificent Seven's disproportionate impact in 2023 is extreme but not an outlier – most of the market’s gains are driven by a comparatively small subset of stocks.  A researcher found that the total U.S. market return from 1926 to 2015 came from just 4% of the starting pool of stocks!8 A 2023 research update examining global stock returns from 1990 to 2020 found even longer odds: a little over 2% of the stocks accounted for all the return! 9Academics will debate the data nuances, but the takeaway is clear: If you fail to include the winners in your portfolio, you will miss out on most or all the market returns.  By indexing broadly, you will be sure to own the winners.10

  3. Stay invested.  Some investors try to improve investment results by getting in and out of the market to avoid portfolio losses.  This is called market timing, a form of active investment management. To succeed, market timing requires both prescience – the ability to forecast the future – and precise timing. Not just once, but twice: When to get out and when to get back in. In my view (and that of many others), there is no effective way to do this short of pure dumb luck. You must stay invested to capture long-term market returns.11

  4. Keep it simple.  GFA portfolios comprise three broad asset classes: stock, bonds, and cash.  We own stocks for their strong inflation-beating performance over time.  Cash and bonds temper stocks’ rough ride and provide liquidity when stocks are down. Some advisors tout complicated “alternative” investments (think hedge funds, derivatives, futures, cryptocurrency, etc., etc.) with claims that they provide stock-like returns with less volatility.  These are costly, active investment strategies; not surprisingly, history has shown that these types of investments generally don’t deliver.12 Other supposed “magic bullets” are fine-print-laden annuity products (sold with fear-mongering exhortations like “Don’t give your gains back to the market!”) and precious metals, notably gold.  The former are abstruse products with returns-limiting costs and caps.  Gold, while a store of wealth for millennia, has provided volatile returns that merely break even after inflation over the longer term.13

  5. Minimize cost.  Numerous studies have shown that, overall, lower-cost investments do better than higher-cost investments.14  This is a key reason indexing beats active management – indexing doesn’t require a staff of high-priced analysts trying to find those mispriced needles in the market haystack. Keep in mind that taxes are the highest cost most investors pay.  Tax minimization is an area a good advisor can add tremendous value.

  6. Tilting at factors.  (Nerd out alert!  Some may find the following discussion of factor investing a little hairy.) Over the past few decades, finance academics have discovered that investments with certain characteristics have historically provided higher returns than the market overall.15 Two of the oldest and best-known of these “factors” are a) small company stocks and b) value stocks.  

Small Cap Effect

Companies can be grouped by “market capitalization” – the total stock market value of the company obtained by multiplying the total shares outstanding by the price per share.  Currently, the company with the largest capitalization is Apple, with a market valuation of approximately $3 trillion!  Small company stocks are generally defined as those with a total market value of a few billion dollars or less.

Studies have shown that, over the long term, small “cap” (capitalization) stocks provide higher returns than larger cap stocks (albeit with a much rougher ride).  The theoretical rationale for this effect is that, unlike a proven winner like Apple, the uncertainty surrounding the prospects of smaller companies makes investors less willing to pay high prices for their shares.16  If the company survives and thrives, these stocks can deliver supersized gains.   

Value Effect

Companies can also be segmented by valuation measures like the price-earnings ratio.  The price-earnings ratio represents the price investors pay for one dollar of the company’s earnings.  

If investors believe a company will consistently outperform and grow its earnings faster than the market overall, they are willing to pay more per dollar of current earnings.  Companies with higher-than-average valuation multiples are called growth stocks.  Apple is a classic example of a growth stock (and one of the Magnificent Seven).

However, if investors feel a company’s long-term prospects are questionable, they pay less. Companies with lower-than-average valuation multiples are called value stocks.

Perhaps counterintuitively, studies have shown that value stocks as a group have delivered higher returns than growth stocks.17  The theoretical rationale for the “value effect” is that investors overreact to current performance, exacerbated by FOMO and panic.  As a result, growth companies often fail to live up to their high prices and consequently provide lower returns, while value companies often do better than expected and provide higher returns.  

Some of you may be thinking, wait a minute, recent market winners have been large-cap growth stocks like the Magnificent Seven!  Indeed, factors are long-term effects that may not apply over shorter periods.  I believe that the theoretical underpinnings of small and value will win out over the longer term and therefore “tilt” my recommended portfolios towards these factors (tempered by the “Diversify widely” principle).

If the above seems somewhat simplistic, I won’t argue.  After watching countless investment wunderkinds touting the next big thing eventually crash and burn, I’ve learned that the market is a tough bogie to beat consistently.  The good news is we don’t need a PhD in finance to share in the rewards of private ownership and free and competitive markets.18  Count your blessings and invest!

1The late John C. Bogle was the founder of Vanguard, a pioneer in index investing and one of the largest providers of mutual funds and ETFs.  Bogle is one of my business and investment idols.

2Using two low-cost Vanguard globally-diversified index funds as benchmarks, in 2022, the moderately aggressive 60% stocks, 40% bonds/cash LifeStrategy Moderate Growth fund (VSMGX) lost 16%, while the more aggressive 100% stocks World Stock ETF (VT) lost only two percentage points more – 18%.  U.S. stocks, represented by the Total Stock Market ETF VTI, lost 19.5%.

3Alphabet, Amazon, Apple, Meta Platforms (Facebook), Microsoft, Nvidia & Tesla.  These seven large tech companies accounted for two-thirds of the total U.S. market’s gains in the first half of 2023!

42023 year-end update: Predictions that the Fed has stopped raising rates and might lower them in 2024 drove broader market gains at the end of the year.

5Some managers try to beat the market by “shorting” a stock – a bet they think it will do worse than the market expects.  Many hedge fund managers use this high-risk strategy with the potential for theoretically unlimited losses. Just ask those managers pummeled by the GameStop "short squeeze" in 2021!

6Standard & Poor’s ”SPIVA” annual scorecard: 

7See S&P’s SPIVA “Persistence Scorecard“:

8John Renkenthaler, “Most Stocks Stink,”, 4/7/2017.

9Bessembinder et al, “Long-term shareholder returns: Evidence from 64,000 global stocks,” 2023 working paper.

10Sure, you will also own the losers, but over time, the winners’ gains beat the losers’ losses.  Stock returns are what academics call “asymmetric” – losses are limited, but gains are theoretically unlimited.  A great example of the latter is Nvidia (NVDA): its stock gained 239% in 2023!  In contrast, the most any stock can lose is 100%.  

11See GFA’s blog on market timing:

12John Renkenthaler, “Do Investors Need Alternative Investments?”, 2/24/2022.  Also, Derek Horstmeyer, “Hedge Funds for the Masses Deliver Ho-Hum Returns – and Have High Costs,” Wall Street Journal 1/4/2024.

13Mark Hulbert, “Gold as an Inflation Hedge: What the Past 50 Years Teaches Us,” Wall Street Journal, 8/8/2021. 

14John Renkenthaler, “3 Reasons to Go Low-Cost,”, 7/19/2016.

15Kimberlee Leonard, “Factor Investing: Definition and 5 Factors,” Seeking Alpha, 8/21/2023.

16“Are Small Caps Worth Investing In?” Morningstar, 11/27/2023

17John Renkenthaler, “Why Value Investing Works”, 6/15/2023

18“Economics Back to Basics: What is Capitalism?” International Monetary Fund, 6/2015