Data Shows Investing is Heavily Biased by Geography
For investors, there’s no place like home. Data shows that investors are heavily sector-biased based on where they live. Openfolio.com, a platform tracking the performance and activity of 40,000 investors, calculated the overall popularity for the top 2,000 stocks and funds owned by its users in the United States. The data was then segmented based on sector and geography. The results are clear: the West Coast of the United States loads up on tech stocks and the Northeast loves financials more than anyone else. The states along the Gulf of Mexico buy more energy stocks, and states in the Midwest are more likely to own industrials. Interestingly enough, the most balanced sector was healthcare, which all geographic regions seemed to own equally. The real question is: what kind of returns did investors get? Over the course of 2014, the average investor on the West Coast led the pack with a 5.9% performance. The Midwest averaged 4.7% and the Northeast got 4.5% returns. The Southeast, which has a bias towards energy stocks, was likely hard hit by the oil price crash with the lowest average of 3.1%. Familiarity with sectors and industries plays a big role, and it makes sense. People exposed to the technology sector in places like Silicon Valley and Seattle are more likely to feel comfortable investing in tech-related equities. While it is a good thing to invest in areas where one feels comfortable, it can also create asset allocation and risk problems. This is why it is important for investors to know their biases and to manage their portfolios accordingly.
on Last year, stock and bond returns tumbled after the Federal Reserve hiked interest rates at the fastest speed in 40 years. It was the first time in decades that both asset classes posted negative annual investment returns in tandem. Over four decades, this has happened 2.4% of the time across any 12-month rolling period. To look at how various stock and bond asset allocations have performed over history—and their broader correlations—the above graphic charts their best, worst, and average returns, using data from Vanguard.
How Has Asset Allocation Impacted Returns?
Based on data between 1926 and 2019, the table below looks at the spectrum of market returns of different asset allocations:
We can see that a portfolio made entirely of stocks returned 10.3% on average, the highest across all asset allocations. Of course, this came with wider return variance, hitting an annual low of -43% and a high of 54%.
A traditional 60/40 portfolio—which has lost its luster in recent years as low interest rates have led to lower bond returns—saw an average historical return of 8.8%. As interest rates have climbed in recent years, this may widen its appeal once again as bond returns may rise.
Meanwhile, a 100% bond portfolio averaged 5.3% in annual returns over the period. Bonds typically serve as a hedge against portfolio losses thanks to their typically negative historical correlation to stocks.
A Closer Look at Historical Correlations
To understand how 2022 was an outlier in terms of asset correlations we can look at the graphic below:
The last time stocks and bonds moved together in a negative direction was in 1969. At the time, inflation was accelerating and the Fed was hiking interest rates to cool rising costs. In fact, historically, when inflation surges, stocks and bonds have often moved in similar directions. Underscoring this divergence is real interest rate volatility. When real interest rates are a driving force in the market, as we have seen in the last year, it hurts both stock and bond returns. This is because higher interest rates can reduce the future cash flows of these investments. Adding another layer is the level of risk appetite among investors. When the economic outlook is uncertain and interest rate volatility is high, investors are more likely to take risk off their portfolios and demand higher returns for taking on higher risk. This can push down equity and bond prices. On the other hand, if the economic outlook is positive, investors may be willing to take on more risk, in turn potentially boosting equity prices.
Current Investment Returns in Context
Today, financial markets are seeing sharp swings as the ripple effects of higher interest rates are sinking in. For investors, historical data provides insight on long-term asset allocation trends. Over the last century, cycles of high interest rates have come and gone. Both equity and bond investment returns have been resilient for investors who stay the course.
