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Five dogs of 2013 that are 2014's stars

Investors should know that what works well in one year doesn't typically repeat in the next. The reverse is also true, as these five market laggards from last year demonstrate: So far, they're the stars of this year. And this leads to a simple lesson that can help us become better investors. The following data are from Chicago-based Morningstar.

First, 2013 was a down year for bonds as the Federal Reserve announced its plans to taper its bond-buying program known as quantitative easing. Financial advisors again tried to time the market with predictably poor results, and the bond market again fooled the experts. Morningstar's core bond index declined by 1.93 percent last year and is up by 2.97 percent so far this year, as interest rates declined.

Second, Treasury Inflation Protected (TIP) bonds, which had been on a tear since 2009, really got hit last year, declining by 6.41 percent. So far this year, the TIP index is up by 3.85 percent.

Third, real estate investment trusts (REITs), which can provide diversification due to low correlations with stocks, missed out on U.S. stock returns last year, earning only 2.07 percent and lagging the U.S. stock market's 32.60 percent return by over 30 percentage points. This year, REITs are up by 13.73 percent, besting U.S. stocks' 1.44 percent return by over 12 percentage points.

Fourth, small-cap stocks generally do better than large-cap stocks. This occurred last year as the small-cap index earned 37.59 percent, or more than six percentage points greater than large-caps. Many investors make the mistake of assuming that small-caps will always beat large-cap stocks with the possible exception being during market plunges. This year, the small-cap index is down 1.85 percent, while large-caps are up by 1.58 percent. It slipped the mind of some investors that the small-cap premium of higher expected returns is compensation for higher risk.

Fifth, utilities were hot a couple of years ago as investors searched for yield and forgot it was total return that mattered. Utilities earned 14.21 percent last year, lagging the return of U.S. stocks by over 18 percentage points. Now, their return this year of 14.21% is ahead of U.S. stocks by over 12 percentage points.

Lesson learned.

It's much easier to predict the past than the future, but the key to investing is staying away from short-term predictions. Compelling data show that investors chase performance and underperform the market as a whole. But there's a powerful force called reversion to the mean.

A simple translation is that last year's winners may be this year's losers. The reverse is also true, and these five losers from 2013 are having a great 2014.

While I'm for owning the entire market and keeping to a broad asset allocation, if you do want to try to outperform the market, you may want to target overweighting recent dogs and underweighting the stars.

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