Wednesday, July 20, 2005

Meridian Quarterly Review

June 30th 2005

The year through June 30th has been pretty much flat. The major U.S. Index the Standard and Poors 500 was down about .77%. REIT’s were the shining stars of the quarter as they recovered from their first quarter slump and surged nearly 15%. I am of the opinion that the run in REIT’s is about over and that new allocation made to REIT’s should be small. Existing allocations should be trimmed to match your individual Investment Policy Statement.

A diversified portfolio of stocks and bonds was up about 1% as of June 30th; once again a diversified portfolio has beat out the S & P 500. While I am happy that a diversified portfolio has continued to hold its own and outperform the major indexes you should know that this won’t always be the case. Occasionally the marketplace goes crazy and favors individual asset classes such as large growth stocks (for which the S & P 500 is a good proxy). For example, during the period between 1995 and 1999 the market as represented by the S & P 500 had an annualized return of 28.30% versus a diversified portfolio return of only 16.22% (only!). While most people would have been thrilled earning 16% annually most were extremely unhappy because they trailed the market by over 12% annually for those five years. The following table shows the difference in dollars an investor would have had with each strategy at the end of the period (1999) had they invested $10,000 in each strategy in 1995:

S & P 500 Diversified Portfolio

$34,800 $21,200

As you can see the market based portfolio had over $13,000 more in it at the end of year five; nearly 64% more than the diversified portfolio. I remember the media and all the wire house brokers talking about the death of diversified portfolios and that large cap growth stocks were the only place to invest an individual’s money. They turned out to be totally wrong and lost investors billions of dollars because they strayed from the number one rule of investing, diversification.

During the period of 2000 – 2004 the Standard & Poors annualized return was -2.46% while a diversified portfolio of stocks was up on average 10.41%, a near perfect reversal of the previous five years. The diversified portfolio returned on average almost 13% per year more during this five year period. The period taken as a whole (January 1995 – December 2004) saw the S & P 500 average 11.87% annually, while a diversified portfolio averaged 13.28%. Over the ten year period the diversified portfolio performed better and with much less fluctuation. At the end of the ten year period a $10,000 initial investment (starting January 1995) in each strategy would have yielded the following results:

S & P 500 Diversified Portfolio

$30,700 $34,800

My point with all of these statistics is not to make your eyes rollback into your head but to demonstrate two things. First, diversified portfolios don’t always win in the short term, they may drastically under-perform the overall market; but those who persevere should be aptly rewarded. Second, a diversified portfolio has less risk and more potential for return. A long term investor is better off in a well diversified, low-cost, index based portfolio than following the latest trends or listening to Wall Street.

We may be entering into another period where diversified portfolios under-perform; if we are this is a perfect time to take stock (no pun intended) and hunker down for the long run.

Enclosed are your quarterly statements, please let me know if you would like to meet to go over them in person.

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