All investors probably wish they had known last year which asset class was going to perform well this year. However, no one can anticipate market movements with such certainty. Investors generally tend to choose asset classes based on past performance, as indicated by the fund flows and asset-class performance charts observed side by side. Flows of money into funds tend to follow performance, a clear example of how investors tend to chase past returns.
During the recent financial crisis, investors pulled money out of stock funds for five years in a row. Flows into bond funds, on the contrary, reached a peak in 2009 and remained high in 2010, 2011, and 2012. Fear of the stock-market decline kept investors in flight-for-safety mode even as stocks began to recover. In point of fact, U.S.-stock returns were negative for only one year, 2008. In all the following years, stocks actually posted gains.
Now, however, the tables are turned, and expectations of rising interest rates do not bode well for bonds in the near future. Despite these expectations, and negative bond performance in 2013 to boot, flows into bond funds still remained positive, although not nearly as high as they had been in previous years.
Diversification does not eliminate the risk of experiencing investment losses. Government bonds are guaranteed by the full faith and credit of the U.S. government as to the timely payment of principal and interest, while stocks are not guaranteed and have been more volatile than the other asset classes. International investments involve special risks such as fluctuations in currency, foreign taxation, economic and political risks, liquidity risks, and differences in accounting and financial standards.
