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A Word About Asset Allocation, first posted May 6, 2019

Updated: Jun 30, 2020

How much of your money should be in stocks? Or bonds? Or real estate? We get these questions all the time, and it strikes me as timely to revisit the matter here in the Spring of 2019.


The RG Bar team addresses allocation a little differently than most investment advisors, for we eschew the traditional 60/40 mix of stocks to bonds. Instead, we subscribe to a financial planning philosophy whereby money that an investor doesn’t need for at least ten years should pretty much all be in equities. For shorter term investment horizons, we typically plan that money an investor needs in five years should be in a bond that matures in five years, that money an investor needs in three years should be in a bond that matures in three years, and so on and so on.


Why do we do that? Much of our asset allocation methodology is based on empirical evidence and our mentality as mean reversionists. Here’s some of the data on which we focus:


The chart below shows that there have only been four ten-year periods ever when the stock market has had a negative return, and all four included either the Great Depression or the 2008 financial crisis.



* Chart from Crestmont Research, https://www.crestmontresearch.com/stock-market/. The S&P500 was launched on March 4, 1957. Data prior to 1957 from Schiller, Robert J.; “Market Volatility,” Chapter 26 (Data Appendix), MIT Press, Cambridge MA, 1989. Dividend and earnings data before 1926 are from Cowles and associates (Common Stock Indexes, 2nd edition, Bloomington, Ind.: Principia Press, 1939.


Four times in more than 120 years of publicly traded companies— not bad. Stocks averaged 11.8% a year annualized return while bonds returned less than half of that. And over any 10-year period, stocks did better than bonds 89% of the time.[i]


The fact is that bonds are subject to inflation risk. Since bond interest payments are fixed, their value can be eroded by inflation. The return during the worst 10-year period for bonds was 10 percent lower than the worst 10-year period for stocks. The chance of incurring real money-- inflation-adjusted-- losses over any 10-year period was seven times greater for bonds than it was for stocks. And while it’s significant that stocks did better than bonds 89 percent of the time over ten year periods, the case for equites becomes even more compelling over 15-year periods, as stocks beat bonds every time and never failed to beat inflation.


On the other hand, bonds would have generated negative real money returns for every single decade from the 1930’s all the way though the 1970’s.


What about real estate? Didn’t do too well during the Dust Bowl years of the Great Depression, of course, but how about recently? The S&P500 is up 269% over the last ten years[ii]-- has the value of your home done that? In all likelihood, not even close. This has been one of the greatest real estate bull markets of all time, and yet again, the empirical evidence in favor of equities is overwhelming.


Therefore, we have a pretty simple view on asset allocation. Invest your long-term money long term, and invest your short-term money short term. The empirical evidence suggests that any money you don’t need for at least ten years should all be stocks.


For investors who have capital that is designated for fixed income, we still encourage investors to put that money to work. Municipal bonds are relatively scarce, and the technical backdrop for the municipal market has solid long-term underpinnings. The size and supply of municipals have remained relatively steady while Treasury and corporate debt markets have experienced dramatic expansions.[iii] Demand for municipal securities has understandably increased and may continue to grow as select provisions of the Tax Cuts and Jobs Act are realized.


Moreover, in what we view as a currently benign rate environment, the coupon income from credit asset classes is looking particularly attractive. Goldman Sachs currently estimates that yields could rise by a further ~1% before the offsetting price reduction would reduce returns in various credit sectors to breakeven. For example, rates or spreads would need to rise more than 197 basis points to generate negative returns in US High Yield.[iv]


In fact, the present difference between the current and breakeven yields for several sectors is so wide that it has historically been breached just a handful of times. For example, that 197 basis point move in high yield bond yields has occurred in just 2% of 12-month periods.[v] Given our expectation for stabilizing global growth, contained inflation, and dovish central bank policy, we consider the likelihood of such moves to be particularly slim.


Yes, the unknowns bear close watch and are likely to generate short-term volatility, but we can expect better visibility in the coming months on several of those key concerns: an uncertain Brexit process, turbulent trade policy, and the possibility of further populist shocks in election outcomes. Investors, in our view, should therefore prepare for emergent risks even as they seek to capitalize on opportunity.


In summary, we see opportunities in recently drawn-down equity prices and a benign interest rate environment. “Risk-on” assets like emerging markets equity for long-term investing look attractive to us, and at the same time, we feel like investors seeking high quality bonds for the other part of their asset allocation are in a reasonable position.



[i] The raw data for treasury bond and bill returns is obtained from the Federal Reserve database in St. Louis (FRED). The return on stocks includes both price appreciation and dividends. The treasury bill rate is a 3-month rate and the treasury bond is the constant maturity 10-year bond, but the treasury bond return includes coupon and price appreciation.


[ii] https://dqydj.com/sp-500-return-calculator/


[iii] Moran, Danielle; “Disappearance of $117 Billion of Muni Debt to Fuel Bond Hunt,” Bloomberg, May 1, 2019.


[iv] Tousley, John; Ashley, James, Tse, Candice; Game of (Un)Knowns; Triannual Insights and Implementation 2019, Edition 2, p.10.; April, 2019.


[v] Ibid, p.10



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