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The Past Is Another Paradigm

By Jim Pearce on April 21, 2017

Except for 2017’s first two trading days, all of the gains in the Standard & Poor’s 500-stock index this year occurred in the first six weeks of the Trump presidency. Since then, stocks have slumped while investors wait for proof that President Trump’s pro-growth agenda isn’t just wishful thinking.

But even if Trump enacts some of that agenda, the demographic realities of the U.S. economy are working against him. It’s no coincidence the U.S. economy grew more rapidly while the baby boomers were in their prime working years and computers were driving enormous leaps in productivity. The result was annual economic growth in the mid-single digits for much of the 1970s, ’80s and ‘90s.

Then, about 15 years ago, the baby boomers—the generation born between 1946 and 1964—began exiting the workforce. At the same time, productivity tapered off because the benefits from automation and data processing had mostly been accounted for. Without the twin engines of demographics and productivity, the U.S. economy will lose steam.  A recent Federal Reserve report estimates annual U.S. economic growth at less than 2% over the next 10 years.

Given this sobering statistic, stock valuations based on the expectation that economic growth will return to its former glorious heights seem like pie in the sky. Certainly, some companies will expand earnings faster than average, just as some sectors will perform better than others. On the whole, though, companies will be competing in what will effectively be little more than a zero-sum game if the Fed’s prediction is right.

That suggests passive investing with index funds designed to mimic market averages may not be as effective in the future. Most investors may be happy earning an average annual return of 6% to 8%, but if that falls between 2% and 4%, they will need to supplement index funds with better-performing individual stocks to generate a bigger gain. One way to do that is to build a diversified portfolio around certain core holdings that should perform well long term.

However, determining exactly what that core holding should be, and what should surround it as ancillary holdings, is much easier said than done. How much money you should put in each ring depends on your financial situation. A retiree living on a fixed monthly pension might have a wide second ring that emphasizes growth and protects against the possibility of inflation whittling away the core’s purchasing power. But a retiree already withdrawing from an IRA may want a big center circle, with more income-producing investments as the core.

Unfortunately, over time most investors inadvertently end up with a mixed bag of investments that bear little resemblance to their performance goals. If this happens and you’re not sure how to fIx it, ask a financial planner to evaluate your portfolio and help you rebuild its core holdings.

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