Fourth Quarter Markets Review
U.S. Stocks overcame significant volatility in recent months to turn in another solid year of performance in 2014. The S&P 500® Index finished the year with a +13.7% return, but was down -0.3% in December. The NASDAQ OTC Composite was also down in December, falling -1.2%, but was up +13.4% for the year. Small capitalization stocks outperformed their large capitalization counterparts in December and the fourth quarter, but substantially underperformed for the year. Small capitalization growth stocks outperformed their value counterparts in the month, quarter and year. Large and medium capitalization growth stocks underperformed their value counterparts in December, the fourth quarter, and the year. We see potential for further gains in 2015, but we also expect markets to face some fresh challenges and an increase in volatility.
Both taxable and municipal fixed income securities turned in strong performance, rising +0.1% and +0.5% in December, respectively, and gaining +6.90% and +9.1% for the year, respectively.
Manage Risk With Asset Allocation
Asset allocation is a very important part of risk management within an investment portfolio. By investing in multiple asset classes, such as stocks, bonds, real estate, etc., that do not have closely correlated returns, investors can lower the variability of the returns that their portfolio experience over time. After an allocation method has been selected, periodically rebalancing the portfolio becomes an integral component to this process.
Through different allocation and diversification strategies, it may be possible to create portfolios with reduced risk (as measured by return variability) that can produce more consistent returns. For example, the S&P 500® Index, which is often used as a proxy for U.S. large cap stocks, fluctuated in annual returns from a low of -37.00% (2008) to a high of 26.47% (2009) for the five years ended December 31, 2012, while the Barclays U.S. Aggregate Bond Index, a proxy for the U.S. taxable bond market, only fluctuated between +4.22% (2012) and +7.84% (2011) over the same time period. During the calendar year of 2008, a portfolio comprised of holdings from both indices would have experienced a smaller decline than one made up entirely of the S&P 500 Index. In 2012, investing only in bonds (as defined by the Barclays U.S. Aggregate Bond Index) would have produced a positive return of 4.22%, but adding stocks to the equation would have increased the return on a portfolio for that year.
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